All three major US stock indexes were eviscerated on Monday, just 24 hours after the Federal Reserve held an emergency meeting and cut interest rates to zero.
Both the Dow Jones Industrial Average and the S&P 500 had their worst day since the “Black Monday” crash of 1987, with the S&P sliding 12% and the Dow turning in its third-worst day ever, falling 12.9%.
The NASDAQ had its single worst day every, dropping 12.3%.
With record-setting days for two of the indexes, it shouldn’t come as a surprise that the volatility index, the VIX, which is used by many to measure how much fear there is in the markets, saw its highest close ever at 82.69. It beat the previous record of 80.74 set during the depths of the financial crisis.
The trading day started with the markets being halted for 15 minutes shortly after the open when the S&P dropped more than 8%, triggering the so-called “circuit breakers” to prevent a full-on panic sell and maintain order.
It didn’t do much good, as the market continued sliding throughout the day, despite the Fed’s announcement of slashing interest rates to zero and more than $750 billion in monetary relief less than 24 hours earlier.
Even with zero percent interest rates and billions of stimulus money, investors are cautious to invest money back into the market without knowing how the coronavirus will impact the US.
“Although the contemporary crisis is loaded with bad news, this has not been its primary problem. It’s the ‘unknown,’” said Jim Paulsen, The Leuthold Group’s chief investment strategist. “Not even health experts understand what this is or where it is headed, and that is the worst possible outcome for investors. Give me bad news any day over complete uncertainty”
Frank Cappelleri, executive director at Instinet, said in a note: “The markets are getting no break with yesterday’s historic Fed actions and COVID-19 dominating the world’s headlines. While the news continues to worsen and with the price action doing things we’ve only seen a handful of other times in the last century, it’s nearly impossible to keep things in perspective.”
“We can’t argue the facts, and we’re dealing with a much bigger issue than just the economy.” he added.
Even President Trump, a day after praising the Federal Reserve for finally lowering interest rates to combat the economic slowdown caused by the coronavirus, said that the outbreak could last well into August and that the US “may be” heading into a recession.
It’s going to take a clear indication that the worst of the outbreak has passed before many investors would be willing to invest in the market again, particularly with so many industries looking for bailouts to survive the crisis.
Yesterday the US airlines asked for a $50 billion bailout in direct aid and loan guarantees to keep the industry afloat, to which President Trump later said at a press briefing “We’re going to back the airlines 100% – it’s not their fault. We’ll be backstopping the airlines and helping them very much.”
Fed Keeps Rates At Zero, Powell Says More Fiscal Support Needed
The Federal Reserve wrapped up its last meeting before the November elections. It announced that it would keep rates at essentially zero until at least 2023. This serves as a signal that it doesn’t see inflation as an issue at all for the foreseeable future.
Fed Chairman Jerome Powell said, “We’re going to continue to monitor developments, and we’re prepared to adjust our plans as appropriate.”
“With inflation running persistently below this longer run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved,” the Fed’s post-meeting statement said.
Uncertainty and the Stock Market
However, the Fed’s latest projections have core inflation staying below their 2% target until 2023. This leaves many observers unsure of the Fed’s actual plan to spur the inflation they desire. This uncertainty caused the stock market to drop after the announcement.
“He noted that targeting an inflation overshoot for ‘some time’ as the statement says, means that they are not targeting a ‘sustained’ overshoot. So how long is ‘some time’ if it isn’t sustained?'” asked AB economist Eric Winograd. “That imprecision is a problem that the committee is going to have to solve to reap the full benefits of the framework shift. It’s not a coincidence that the stock market, which had been in positive territory, flipped negative after the chair’s comments.”
“He’s the great and powerful Oz. Investors got duped. They thought enhanced forward guidance meant something, but when they peeked behind the curtain they realized the Fed didn’t do anything, and the market rolled over,” said Michael Arone, chief investment strategist at State Street Global Advisors.
Jon Hill, a senior fixed-income strategist at BMO, added “This is dovish – lower rates for longer, higher equities, weaker dollar. The Fed is saying we’re not hiking in 2023, maybe in 2024 … What they’re saying is these are our goals. We expect to have just barely met them and even then, they’re not raising rates.”
Stimulus and Economic Recovery
Stepping ever-so-slightly into the political realm, Powell said that Congress should pass another stimulus package to support the economic recovery. He then identified unemployment aid, small business relief and funding for state and local governments as three key areas.
“More fiscal support is likely to be needed,” Powell said. “The details of that are for Congress, not the Fed.”
Republicans have repeatedly stated that they won’t provide additional funding to bailout poorly managed cities and states as part of any additional stimulus bills.
Fed to Keep Rates At Zero, Worried About Market Crash Later This Year
The Federal Reserve will keep rates at near zero percent for the foreseeable future. Also, a few members feel worried about a second wave of the coronavirus crashing the markets later this year. These are according to the minutes of the June 9-10 meeting.
Federal Open Market Committee members voted to keep the benchmark short-term borrowing rate in a range of 0%-0.25%. They also said that, until the economy “had weathered recent events,” they would keep it there. Without providing specifics, the notes also mention that “a number” of members believe there is a high probability of additional “waves of outbreaks” of the coronavirus.
This worry over additional outbreak waves and the economic damage it could bring led the FOMC committee to downgrade their economic outlook from the April meeting. The said meeting had predicted a more benign baseline forecast.
The members also indicated that they will begin providing the markets with stronger guidance about future interest rate moves. However, Fed watchers don’t expect the committee to begin providing this guidance any earlier than the September meeting.
“In particular, most participants commented that the Committee should communicate a more explicit form of forward guidance for the path of the federal funds rate and provide more clarity regarding purchases of Treasury securities and agency [mortgage-backed securities] as more information about the trajectory of the economy becomes available,” the minutes said.
Milestones and Metrics
The committee also discussed what milestones they will use to determine an appropriate time to start raising interest rates. When they did, the metrics proposed has split the committee.
In 2012 for example, the Fed said it would keep rates at zero until the unemployment rate fell below 6.5%. Alternatively, they also said it would keep zero rates until the inflation goes above 2.5%.
In June’s meeting, a “number” of members said any interest rate increases should be tied to the Fed’s 2% inflation target. Meanwhile, a “couple” favored using the unemployment rate. A “few” members suggested the committee set a specific date.
The FOMC also released its expectations for GDP over the next few years. The median GDP projection for 2020 was a contraction of 6.5%. A 5% increase in 2021 and a 3.5% in 2022 will follow this. However, they acknowledged “that there remained an extraordinary amount of uncertainty and considerable risks to the economic outlook.”
Trump on Powell
Meanwhile, there’s a bit of good news for Federal Reserve chairman Jay Powell. It appears he has slowly won over his most vocal critic, President Trump.
During an interview on Fox Business News, Trump said Powell has “stepped up to the plate” and he’s happy with Powell and Treasury Secretary Steve Mnuchin for the work they’ve done to help the economy recover.
“I would say that I was not happy with him at the beginning, and I’m getting more and more happy with him, I think he’s stepped up to the plate. He’s done a good job, he’s had to liquify a little bit, let us liquify, put out the money that you needed, and I would say over the last period of 6 months he’s really stepped up to the plate.
“I can tell you I’m very happy with his performance, and Steve Mnuchin, I think they’ve both done a very good job, they’re working together very closely.”
Fed Keeps 0% Rates Until At Least 2022
Confirming what many expected, the Federal Reserve announced yesterday that it will keep rates at zero percent for the foreseeable future, perhaps well into 2022.
During a press conference, Fed Chairman Jerome Powell said, “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.”
The Fed did acknowledge that economic conditions “have improved” in the last few months. However, none of the members indicated an urgency to raising interest rates. In “dot plots,” each member plots their forecast for interest rates. However, in this case, only two of the 17 members saw a case for hiking rates in 2022.
The decision to keep rates at near-zero percent indefinitely is an attempt to get the economy back to where it was before the coronavirus pandemic. During the said pandemic shut down our country and plunged our economic output by an estimated 50% this quarter.
The outlook from Fed members is for real GDP to contract by 6.5% in 2020. This comes with an unemployment rate of 9.3% by the end of the year. The members are much more optimistic about 2021. Members projecting an unemployment rate down to 6.5% and real GDP reaching 5%.
There are already positive signs, with last week’s controversial jobs report showing 2.5 million jobs were added in May.
Powell cautioned, however, that the millions of jobs lost will unlikely return quickly, if ever.
He says that many businesses may simply not reopen. Alternatively, he also says that jobs eliminated during the pandemic may not exist in the “new world order.”
The Federal Reserve keeping rates low while printing trillions of dollars to help the country recover from the coronavirus pandemic. With this, there are some very real fears that inflation is going to spiral out of control. Many fear that this will soaring well above the Fed’s target of 2%.
Thus far, the Fed members seem unconcerned about the possibility of runaway inflation.
Plans and Expectations
The average Fed member expects inflation (as measured in core personal consumption expenditures) of just 1.0% in 2021, increasing slightly to 1.5% in 2021.
The Fed will also continue to do its part to keep liquidity in the markets by buying up assets including mortgage-backed securities and Treasurys. The FOMC told the New York Fed to keep purchases “at least at the current pace,” which indicates about $80 billion per month for Treasuries and about $40 billion per month for mortgage-backed securities.
These actions along with other quantitative easing measures have inflated the Fed balance sheet to a record $7 trillion, a number that Powell has indicated he is comfortable with.
During a webinar hosted by Princeton University a few weeks ago, Powell said that the Federal Reserve has “crossed a lot of red lines that had not been crossed before and I’m very comfortable that this is that situation in which you do that and then you figure it out afterward.”
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