Fed Changes Little In Its Statement

As expected, the Fed kept the Fed funds rate the same which is in between 2% and 2.25%. As I have discussed in previous articles, ever since Powell took the helm as Fed chair, the Fed statement has been short and has provided little detail into the Fed’s thinking. After shrinking in the past few months, the November statement is as slim as it can get. The image below shows the statement and the changes to it. There were only 2 material changes. The first change is the Fed said the unemployment rate declined instead of saying it stayed low. That gives us no color into the Fed’s thinking as it just tells us the literal change in the unemployment rate. I think the Fed should mention the prime age labor force participation rate and the underemployment rate, but it’s not a surprise it stuck to that metric.

The second change is the Fed stated fixed business investment growth has moderated since its rapid pace earlier in the year instead of saying it grew strongly. That’s because the Q3 GDP report showed business investment growth increased 0.8% instead of 8.7% in Q2 and 11.5% in Q1. The Fed needs to recognize that business investment growth slowed because the fiscal stimulus is losing steam. I don’t expect Q4 business investment growth to come close to the levels seen in the first two quarters.

No Interference In The Market

This statement is up for interpretation as most are. The Fed left a lot of the recent economic weakness out. You can say this is intentional or that the Fed just always wants to keep these statements brief. Ultimately, both these goals start with the same mindset. If the Fed doesn’t want to comment on the recent volatility in stocks, it’s because it wants to avoid affecting the market. If the Fed wants to keep the statements short, it’s doing so to stop interfering with the market. That’s a different philosophy than the Fed had under Yellen where there were long statements and reactions to the stock market’s movement.

To be fair, it’s not obvious that Yellen would have made a comment on the October volatility because the S&P 500 only fell close to 10%. However, Yellen’s Fed did often comment on stocks by saying they had excessive valuations. It’s not the Fed’s job to keep the stock market up. Powell is keeping to that mandate. It’s not that he doesn’t want the Fed to be transparent because he is doing long press conferences which are published on YouTube. We’ll get another one of those on December 19th which is in about 5 weeks.

Personally, I don’t want the Fed to discuss small bouts of volatility because they are normal. Every bull market has corrections. However, I think the Fed should discuss the weakness in the housing market, the tariffs causing economic weakness and inflation, accelerated wage growth, and weakness in the auto market. As you can see from the chart below, when new home inventory gets above 7 months, it usually indicates a recession is coming. If inventories stay above 7 months for the rest of the year, I’ll be looking for a recession in 2020.

Stock Market Reaction To Fed Meeting

As you can see from the chart below, leading up to the Fed decision on Thursday, the S&P 500 fell on Fed decision days 5 times in a row. With the decline on Thursday, this streak has extended to 6 which is the longest ever. The S&P 500 fell 0.25%, the Nasdaq fell 0.53%, and the Russell 2000 fell 0.25%. The VIX increased 2.2% and the CNN Fear and Greed index increased from 25 to 29 despite the modest volatility.

The stock market was down at 2:00 PM when the statement came out. It fell afterwards and then closed very close to the price it was at when the statement came out. I don’t take that much stock in the losing streak on Fed days. The market doesn’t like the hawkish Fed, but rates aren’t problematic enough to push overall returns negative this year, so it’s not worrisome yet. The problems will quickly multiply if the Fed raises rates above the long-run rate next year. The scary part of this statement is if the Fed ignores the cracks in the economy, it might ignore the bigger problems next year. Eventually, the Fed will need to react to the economic weakness and volatility in stocks.

The best sectors were the financials and real estate as they increased 0.11% and 0.32%. The financials should like rising rates and the fact that the curve hasn’t inverted. However, the weakness in the housing market will hurt mortgage volume. Recently, FICO announced lenders will look into bank account information if borrowers are denied because of a low credit score. That’s good news for borrowers with no credit experience, but it’s also a sign of desperation by banks.

In the September consumer credit report, credit was up $10.9 billion which missed estimates for $16.5 billion and last month’s increase of $22.9 billion. Growth in non-revolving credit, catalyzed by student loan debt and auto debt increased by $11.2 billion which was down from $18.3 billion in August. Non-revolving debt, which is credit card debt, fell $0.3 billion.

The worst sectors were communication services and energy which fell 0.93% and 2.2%. Oil prices are pushing energy stocks lower, not the Fed.

Treasury Market’s Reaction

The Treasury market barely reacted at all to the Fed’s decision. The 2 year yield increase 1 basis point to 2.96%, but that move already occurred before the statement came out. The 10 year yield was flat on the day and increased 1 basis point to 3.24% after the statement. There is now a 30 basis point spread between the two bond yields. That’s great considering that the Fed is about to raise rates 4 times in 2018. The real yield is carrying the 10 year yield higher as the breakeven rate has fallen recently. There is now a 75.8% chance of a rate hike in December which is down from an 80.8% chance of at least one hike.