Investment thesis: This article does not focus on any investments. It looks at the public statements of Federal Reserve presidents to try and determine the Fed’s interest rate policy, which obviously has a direct impact on the stock market. As Marty Zweig used to say, “Don’t fight the Fed.”
As is typical of the weeks after a Fed meeting, this week was full of commentary from Federal Reserve presidents. Let’s start with Chicago Fed President Evans, whose speech earlier in the month contains his base economic outlook (emphasis added):
“As I noted before, I expect the third-quarter growth number to be big simply because of the restart of the economy from the most severe shutdowns of last spring. After this, I expect more moderate growth in the fourth quarter, with the level of GDP still about 5 percent below its pre-pandemic level at the end of this year.“
A large 3Q20 number would be the result of math as much as a strong rebound. But as Evans also notes, there’s still a tremendous amount of damage. The best example of this is the poor condition of the labor market, where initial unemployment claims are still at historically high levels and the unemployment rate is 8.4%.
Evans sees a long road ahead (same link):
“Improvements in our control of the virus should allow growth to proceed at a moderate pace, though I don’t expect activity returning to its pre-crisis level until later in 2022.”
In that speech and his appearance this week, he re-emphasized the need for fiscal support:
““Fiscal support is just fundamental,” Evans said at a virtual meeting of the London-based Official Monetary and Financial Institutions Forum.”
Cleveland Fed President Mester also sees a weak recovery.
““We’re still in a deep hole, regardless of the comeback we’ve seen,” Mester said during a virtual symposium. “We are recovering now, we see it, but it’s not broad based recovery yet and it’s not what I would call a sustainable recovery. I think it’s still fragile,””
She specifically noted the weak situation in retail and leisure, which I highlighted earlier this week. You can add the energy sector to the list along with the financial sector, which is about to report increased losses as a result of the pandemic. Because of this weakness, she argued for additional fiscal stimulus.
Fed Vice Chair Clarida re-emphasized the Fed’s intention to keep rates low until inflation averages 2%:
““Rates will be at the current level, which is basically zero, until actual observed PCE inflation has reached 2%,” Clarida told Bloomberg Television, referring to the Fed’s preferred measure of prices.
“That’s ‘at least.’ We could actually keep rates at this level beyond that,” Clarida said. “But we are not even going to begin thinking about lifting off, we expect, until we actually get observed inflation… equal to 2%.””
Remember that the Fed now has a 2% average inflation target; if inflation runs below 2% for a year, it could theoretically run over 2% for a year or more (depending on how far over 2% the inflation rate rose) before triggering a Fed rate hike. Here’s a graph of the PCE price index to show just how long that might be:
The total PCE price index (in green) has barely been higher than 2% since 2012.
Boston Fed President Rosengren is less optimistic about growth:
“While I expect the economy to recover in time, my own expectation is that it will be more gradual than the median forecast of FOMC participants. The reason for my differing outlook hinges on several challenges that, I believe, the economy could face in the coming months. First, I am concerned that a second wave of COVID-19 infections this fall and winter is likely, which could cause some states to impose new restrictions on mobility and face-to-face interactions. Even without added restrictions, the added risk of infection from a second wave could sap some of the willingness of consumers and businesses to spend and invest. Second, additional support from fiscal policy, which I believe is very much needed, seems increasingly unlikely to materialize anytime soon. The occurrence of a second wave could result in more fiscal actions, but their impact on the economy would probably not be realized until early next year. Third, I expect that financial spillovers from businesses impacted by the virus will become a more significant headwind going forward. Finally, my forecast reflects my concern that workers displaced by the pandemic may find it difficult to quickly transition to new jobs, with more furloughs turning into permanent layoffs as many businesses remain troubled.”
He is the first Fed President to note the last two. Later in the speech, he develops the financial spillovers idea as it relates to banks. As businesses continue to have problems paying mortgages, banks will not only increase loan loss reserves but also tighten lending standards, which will further constrain credit creation. As for weaker employment growth, I think it’s highly likely that the jobs rebound will grow increasingly difficult as consumer-facing businesses continue to downsize and declare bankruptcy. I am also expecting a large increase in manufacturing automation, further manufacturing employment.
Finally, Chairman Powell’s Congressional testimony specifically called for more fiscal spending (emphasis added):
“Federal Reserve Chairman Jerome Powell urged Congress on Wednesday to agree to inject more cash into the economy. “We’ve basically done all the things we could think of,” he said, referring to the central bank’s policy of keeping interest rates near zero and pumping cash into the financial system.”
The conclusion from all these presidents’ comments is clear: interest rates will be very low for an extended period of time.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.