The Fed’s “lower-for-even longer” pledge fails to soothe stocks

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2020 Midyear Outlook:
  • U.S. economy: Looking for a full recovery by late 2021, albeit with high unemployment.
  • Global economy: More monetary and fiscal stimulus is needed to keep businesses afloat.   
  • Policy watch: No Fed interest rate hikes until well after the economy has healed.
  • Fixed income: Lean into higher-risk assets to generate income.
  • Equities: Focusing on quality across the board (and dividend payers, too).
  • Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.

Quote of the week:

“The beauty of empowering others is that your own power is not diminished in the process.” —Barbara Coloroso 

The Fed keeps rates down but ups its outlook

At its September 15-16 meeting, the Federal Reserve maintained its target fed funds rate at 0%-0.25%. But with the U.S. economy recovering at a pace that has surprised financial markets (and the Fed, too, apparently), Chair Jerome Powell and his colleagues upwardly revised their projections for growth and employment. Compared to June, the last time it issued forecasts, the Fed now expects:
  • A GDP growth rate of -3.7% (annualized) for 2020 as a whole, up from -6.5%.
  • A headline unemployment rate of 7.6% by year-end, down from 9.3% (and 8.4% currently).2
As for the Fed’s outlook on interest rates, the closely watched “dot plot” showed that among the 17 members of the Federal Open Market Committee — the group within the Fed that sets monetary policy — only one anticipates higher rates by 2022. And a large majority foresees no rate increases through 2023.
In terms of inflation, the Fed reemphasized that it will encourage prices to increase at rates “moderately above” its 2% target “for some time.” This strategy, previously announced at the Fed’s annual August symposium, is designed to offset the extended period during which inflation has run well below 2%, which includes the early months of 2020 in which the labor market was still strong. Indeed, the core PCE Index, the Fed’s preferred inflation barometer, last topped 2% in December 2018 and registered just 1.3% in July.3
At last week’s post-meeting press conference, Powell touched on more than just monetary policy. Although Fed officials are normally hesitant to call for specific Congressional actions to help the economy, he once again made it clear that more federal spending is needed – both today and in the future – because the U.S. continues to face long-term risks from the aftermath of the coronavirus crisis.
Helping the labor market return to its formerly robust state is a top priority. The Paycheck Protection Program (PPP), which provided forgivable loans to small businesses to pay salaries, utilities, rent and the like, could use replenishment. Also, state and local budgets remain in dire need of federal assistance, particularly as many schools nationwide have reopened. And while enhanced unemployment benefits have just started to come back online in most states due to President Trump’s executive orders, that money ($300/week) is only half the amount paid under the original provision. Moreover, it will run out in just over a month as nearly 30 million Americans continue to draw from a limited pool of funds originally earmarked for disaster relief.
Although the U.S. economy may be strong enough to survive the resulting income cliff, we think an economic policy error – whether by the Fed or by Congress and the White House – is now the primary source of risk for a “double-dip” recession. This occurs when a recession (like the one experienced in the first two quarters of 2020) is followed by a brief recovery (such as we are currently seeing in the third quarter) and then by another recession.
For now, segments of the U.S. economy that are able to function amid the ongoing pandemic are doing so. These include housing, technology, manufacturing and consumer spending on goods. In contrast, spending on services like travel and leisure remains understandably depressed. So with entire industries still closed or well below their operating capacities, the economy is highly unlikely to sustain the third quarter’s heady annualized growth rate of around 30% (according to some estimates) in the final months of the year.
Until a reliable vaccine is developed and widely available, which would provide a major economic boost, significant rises in inflation or longer-term interest rates are not imminent concerns, in our view. Therefore, we see little scope for major changes in the Fed’s monetary policy approach for a year or two, and perhaps beyond.

Can the Fed’s role expand to address income inequality?

Even as the Fed grapples with an already challenging set of employment and inflation objectives, some members of Congress would like the central bank to broaden its mandate to include reducing income inequality. That wish is unlikely to be granted, however.
That’s not because of indifference on the part of the Fed, which has often expressed concern that lower-income workers have been disproportionately hurt as the coronavirus has forced many businesses in the service sector to close or drastically reduce headcount.
Indeed, one of the many tragedies of 2020 is that a lot of folks were just starting to be included in the economic expansion when the pandemic hit. For example:
  • Workers in low-skill jobs were enjoying faster wage growth, thanks to a low unemployment rate.
  • The labor force participation rate for women was rising, resulting in a smaller gender gap.
  • The unemployment gap between white and black workers was narrowing.4
The common driver behind those improvements? U.S. economic growth outpaced its potential for much of 2018 and 2019, providing the economy with a jolt of momentum. The Census Bureau’s 2019 report on income and poverty in the United States, released last week, included similarly positive trends: Median household income had risen last year to an all-time high of $68,938, and the difference in income between those in the 10th percentile and 90th percentile had shrunk.5
Favorable developments like these were disrupted or seriously threatened when COVID-19 hit, dragging the economy into recession and severely damaging the labor market. Many of the income gains enjoyed by women and minorities were quickly reversed or eliminated.
Can the Fed quickly rekindle pre-pandemic improvements in income equality? Not on its own, unfortunately. Monetary policy is a blunt instrument, and the Fed simply doesn’t have the necessary precision in its policy toolkit to do so. But what the Fed can do is seek to extend the length of economic cycles and allow the economy to run hotter, sooner by fostering the dynamics that were present late in the last cycle.
We believe this would benefit workers in lower-skill jobs, women and people of color — groups that generally have seen their employment prospects and wages improve only at later stages of the business cycle, when the economy tends to operate in higher gear. Even if explicitly targeting income inequality is beyond its reach, this is a Fed that wants to see the proverbial punchbowl continuously refilled until all guests at the party have quenched their thirst.
  1. Bloomberg
  2. Federal Reserve
  3. Haver
  4. Bloomberg
  5. U.S. Census
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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