MANHATTAN (CN) — There is no firm date yet, but the Federal Reserve has essentially begun the countdown for when it will cease its bond-buying program, easing Wall Street’s concerns for now and propping up markets once again.
Since last August, the Fed has taken an atypical approach to inflation, focusing instead on “shortfalls of employment from its maximum level” and a longer-run goal of 2% average inflation. The central bank has consistently said it would maintain the $120 billion monthly bond purchases until it saw “substantial progress” in both inflation and the job market.
In a speech at the annual Jackson Hole symposium, Federal Reserve Chair Jerome Powell said the Fed would not yet halt its purchases of Treasuries and mortgage-backed securities, a process known colloquially as tapering.
“My view is that the ‘substantial further progress’ test has been met for inflation. There has also been clear progress toward maximum employment,” said Powell, adding, though, that “we have “much ground to cover” to reach maximum employment.
For Wall Street doves, Powell presented even more good news: the Fed’s moves on bond purchases would not correspond to any change in interest rates.
“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test,” he said. Since March 2020, the Fed has maintained a 0% to 0.25% interest rate for federal funds.
Many investors expected the Fed would not suddenly taper its bond purchases without giving ample warning to Wall Street, with some saying the Fed learned its lesson after the 2013 “taper tantrum” following an impromptu mention of tapering during a congressional hearing.
Investors, who heavily analyze pretty much anything that flows from the Fed chair’s mouth, gained following the speech. By the closing bell on Friday, the Dow Jones Industrial Average gained 241 points, a 0.69% increase, while the S&P 500 and Nasdaq gained 0.89% and 1.23%, respectively. Two of the three markets are now at new record highs, with the S&P 500 at 4,509 points and the Nasdaq hitting 15,129 points. The Dow is just 60 points shy of a new record, at 35,454 points.
Throwing a bone to investors who might be a little rattled that the Fed would soon leave, Powell added that when the Fed takes its foot off the gas pedal for bond purchases, it will remain in the market. “Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions,” he said.
The Fed has been pleased with the job market’s recovery, but unemployment has not dropped as fast as some had hoped. For the week ending Aug. 21, initial claims rose slightly to 353,000, compared with 349,000 claims the prior week. However, continuing claims fell 3,000 to 2.86 million the week ending August 14.
“We expect jobless claims to remain on a downward path as the labor market continues to recover, but progress will be more fitful as claims get closer to pre-pandemic levels,” wrote Nancy Vanden Houten, lead U.S. economist at Oxford Economics. “We don’t expect the end of emergency benefits to lead to an immediate jump in employment.”
She notes other factors may be more important. “In the near-term other factors – including the course of the delta variant of the coronavirus and access to child care – will probably have a bigger impact on the labor market,” she wrote.
In his speech, Powell also touched on delta, saying the variant of Covid-19 “presents a near-term risk” and that the Fed has been watching its spread.
The rise of cases due to the delta variant has been worse than the initial wave of infection, and the fact that the virus is more contagious than smallpox has medical officials concerned. However, with vaccinations continuing to rise, the impact of delta may soon start to wane, a fact that investors seem to have picked up on.
“The case growth can be seen as a national wave – as infection rates are up across the board – but the primary medical risks remain concentrated in areas with low vaccination rates,” wrote Brad McMillan, chief investment officer at Commonwealth Financial Network. “We are seeing severe localized outbreaks, but they are limited throughout most of the country. We are seeing glitches in some markets – labor and supply chains – but, in general, conditions are improving. That is what is driving the financial markets.”
Tom Essaye of the Sevens Report agrees, writing in an investor’s note that “markets have adopted the view that the delta wave in the U.S. has peaked and as such the economic headwind has also peaked.”
He cited predictions from the Institute for Health Metrics and Evaluation, a think tank founded by the Gates Foundation, which has stated that the peak of the current delta outbreak occurred on Aug. 21. Essaye noted the IHME’s past predictions on the path of the virus have been fairly accurate.
According to the latest data, both new cases and hospitalizations are dropping, while IHME predicts new daily cases will drop by 50% by October. Essaye wrote that “if this is the worst of any Covid-inspired economic slowdown, then the macro-economic outlook remains very bright (and the economic recovery will remain strong).”
Wall Street may be mollified by delta, but the variant has taken its toll on consumers. According to the University of Michigan’s consumer sentiment index, the surging delta variant and inflation have caused a brutal 11-point drop since the end of July.
“The August free-fall in confidence was in response to mounting issues, including rising inflation, small wage gains, and slower declines in unemployment,” said the survey’s chief economist Richard Curtin in a statement. “The falloff also reflected an emotional response to people’s dashed hopes that the pandemic would soon end and lives could get back to normal.”
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