The Power of The Pause: Fed Stands Pat, Stocks Soar

“The sage acts by doing nothing.” — Lao Tzu

No one was surprised but it was welcome news, nonetheless. The Federal Reserve announced Wednesday, at the conclusion of its two-day policy meeting, that it would leave its benchmark short-term fed funds rate at 5.25% to 5.50%.

The action (or rather, non-action) was widely expected, but Wall Street popped the champagne corks anyway.

The main U.S. stock market indices closed sharply higher on Wednesday, as follows:

  • DJIA: +1.40%
  • S&P 500: +1.37%
  • NASDAQ: +1.38%
  • Russell 2000: +3.52%

The Dow Jones Industrial Average closed at a record high; the S&P 500 and NASDAQ hit 52-week highs. The small-cap Russell 2000’s surge is a reflection of economic optimism. Early-cycle bull markets are when small-caps have historically outperformed.

The recent sharp decline of the benchmark 10-year U.S. Treasury yield (TNX) has lent considerable mojo to the equity markets. The TNX fell by a whopping 4.11% Wednesday, to settle at 4.03%.

The CBOE Volatility Index (VIX), the so-called “fear index,” fell roughly 1% on Wednesday to sit at 12.17, a four-year low.

At the same time, U.S. economic growth remains on track, and unemployment hovers at a 50-year low, amid cooling inflation.

Throughout 2023, the pessimists and partisan hacks have whined about a supposed recession, to which my rejoinder is: Best… recession… ever!

Powell Stays Upbeat

At his customary post-meeting press conference Wednesday afternoon, Fed Chief Jerome Powell managed to avoid screwing the pooch.

Powell’s remarks Wednesday were mildly reassuring and did nothing to derail Wall Street’s good vibes about monetary policy. Sometimes at his pressers, Powell is gratuitously voluble and tanks the stock market by making remarks that are more hawkish than the actual policy decision. This time around, we were spared this unfortunate dynamic.

“Inflation has eased from its highs, and this has come without a significant increase in unemployment,” Powell said. “That’s very good news. But inflation is still too high. Ongoing progress in bringing it down is not assured and the path forward is uncertain.” But he also stated that the Fed’s policy rate is at or near its peak.

Powell’s commentary was sufficiently dovish to please investors. Bullishness already had been pervading the market. Analysts at Goldman Sachs (NYSE: GS) wrote in a note last Sunday that the Fed’s rate cut cycle will likely begin in July 2024.

Lower interest rates, of course, tend to be positive for the stock market, especially for growth-oriented investments such as technology stocks. When interest rates are low, the discount rate used to assess the present value of future cash flows is also low. This can result in higher present valuations for stocks because future earnings are less heavily discounted.

The Fed’s Elbow Room

Favorable inflation data this week at the wholesale and consumer levels gave Powell and his minions sufficient leeway to once again pause.

Wholesale prices held steady in November, the Labor Department reported Wednesday. The producer price index (PPI), which measures a broad range of prices at the wholesale level, was flat for the month, following a 0.4% decrease in October but still lower than the consensus estimate for a 0.1% gain. On a year-over-year basis, headline PPI rose only 0.9%, after peaking above 11.5% in March 2022.

The “core” PPI (excluding food, energy, and trade services) also was unchanged versus the estimate for a 0.2% rise. Core PPI edged up 0.1%, representing a 12-month gain of 2.5%.

The PPI report followed the Labor Department’s release Tuesday of its consumer price index (CPI) for November. The CPI rose 3.1% over the last 12 months, down from 3.2% in October and from 3.7% the two months before that.

On a monthly basis in November, the CPI rose 0.1%, with a 6% decline in gasoline prices offset by the continued rise in shelter costs, notably rents. Core CPI, which excludes volatile food and energy prices, remained unchanged at 4.0% in November, largely because it lacked the downward pressure of falling energy prices (see the following chart).

The new year is shaping up to be generally bullish for stocks and bonds. To be sure, we still face several risks. Political dysfunction in Washington, D.C., could lead to government shutdowns due to budgetary impasses, and the wars in the Middle East and Eastern Europe could sow further geopolitical mayhem. As the stock market rally continues, we’ll likely see dips along the way, depending on the headlines.

However, if the U.S. central bank is perceived as responsive to prevailing economic conditions and willing to adjust its policy stance accordingly (as it demonstrated Wednesday), investors will be less inclined to panic during market downturns.

The widespread notion that the Fed is ready to cut rates, if necessary, will help prevent extreme market reactions and contribute to a more orderly and less volatile market environment.

While challenges and uncertainties persist, the pause remains a powerful tool in the Fed’s arsenal.

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John Persinos is the editorial director of Investing Daily.

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This article previously appeared on Investing Daily.