The Federal Reserve's Unspoken Truth

Originally posted at

The Federal Reserve's latest policy announcement has generated a lot of opinions about its implications for the capital markets. What it didn't generate is a lot of movement in the stock market.

The September Federal Open Market Committee (FOMC) meeting was a two-day affair that concluded on September 20 with the issuance of an updated policy directive, the release of updated economic and policy rate projections, an announcement that the Federal Reserve will start its balance sheet normalization process in October, and a press conference by Fed Chair Yellen to discuss it all.

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There was a whole lot of information to digest. The key talking points from the Fed Day bonanza included the following:

  • The target range for the fed funds rate was left unchanged at 1.00% to 1.25%. The vote was unanimous.
  • The Federal Reserve said it will start its balance sheet normalization process in October in accord with the framework laid out in the June 2017 Addendum to the Committee's Policy Normalization Principles and Plans
  • 12 of the 16 Fed members still project a third rate hike in 2017
  • 11 of the 16 Fed members project three rate hikes in 2018
  • The economic effects of the hurricanes are transitory and unlikely to materially alter the course of the national economy over the medium term
  • There was little change in the central tendency economic projections, although it is worth noting that the real GDP growth outlook for 2017 was revised slightly higher while the PCE inflation outlook was revised slightly lower
  • The median longer run fed funds rate — the so-called neutral rate — was reduced from 3.0% to 2.8%
  • Fed Chair Yellen said the Federal Reserve could stop its balance sheet roll off and resume reinvestment if there is a material economic deterioration that cannot be aided effectively with a reduction in the fed funds rate alone. However, she issued a caveat that the hurdle for changing the balance sheet roll-off plan is high.
  • Ms. Yellen also volunteered that the Federal Reserve is monitoring inflation closely, and said that a change in policy would be necessitated if the Federal Reserve ultimately concludes the factors driving low inflation are persistent, and not transitory


The S&P 500 closed the session on September 19 at 2506.65. It closed the session on September 20 at 2508.24. As of this writing, the S&P 500 was trading at 2500.07 versus the prior week's closing level of 2500.23.

Despite being billed in some circles as the most important FOMC meeting yet, the stock market basically ran flat-footed in its midst.

Score that unchanged posture a victory for the Federal Reserve's communications policy.

By and large, the policy prescriptions written by the Federal Reserve were in-line with the prevailing narrative that Fed watchers were writing in front of the meeting. The lackluster response by the stock market, then, was simply a reflection of the understanding that the meeting, the projections, and the press conference didn't provide any real surprises.

One could perhaps point to the lowering of the median estimate for the longer run fed funds rate from 3.0% to 2.8% as a surprise — and even a pleasant one for a stock market that has feasted on the persistence of low-interest rates.

There is one, key reason why that tempered outlook didn't excite the stock market masses: market participants know that the long-run outlook is highly uncertain and that a lot can happen in the interim to alter it.

One More Thing...

One thing that could happen very soon is the appointment of a new Chairman of the Federal Reserve Board of Governors.

Ms. Yellen's term as Fed Chair ends on February 3, 2018, and President Trump has been coy about whether he will appoint her for another term or nominate a new Fed Chair, which some pundits think could be former Fed Governor Kevin Warsh.

That will be an article topic for another time.

For now, Ms. Yellen is the Federal Reserve's guiding voice, and from our vantage point, she sounded as authoritative in her views as she has ever sounded at a press conference.

That was an appropriate disposition, too, considering she is overseeing the beginning of an unprecedented unwinding of the Federal Reserve's .5 trillion balance sheet.

Only time will tell if it is a misguided endeavor, but starting small (very small actually relative to the size of the balance sheet) is a prudent first step to test the financial market waters.

What It All Means

While Ms. Yellen repeated the Federal Reserve is not on a preset course with its monetary policy, the unspoken truth of the matter is that the Federal Reserve has a tightening bias — and that's without any true accounting for the passage of a tax reform plan that will presumably lead to stronger economic growth (which should presumably invite higher inflation).

The policy rate projections from Federal Reserve members point to the prospect of a less supportive interest rate backdrop ahead. Notwithstanding the "lowflation" seen at this time, Federal Reserve members still largely believe the economy is on a firmer footing, which is why Ms. Yellen has sounded more confident in communicating the decision to walk away from the Federal Reserve's extremely loose monetary policy.

What the capital markets think of that strut will be better defined in the coming weeks and months.

If the Federal Reserve is correct with its thinking that the US economic activity will evolve in a positive manner, higher policy rates and market rates are going to be seen and that will pose a challenge for the stock market that hasn't been seen in years.

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Chief Market Analyst