Preparation pays dividends. Stock-market investors took the Federal Reserve’s decision Wednesday to begin tapering its monthly bond purchases without a hitch, erasing early losses to see the Dow Jones Industrial Average
S&P 500 index
and Nasdaq Composite
score a fourth consecutive round of record closes.
“This taper was probably the best telegraphed or advertised move in monetary policy history,” said Art Hogan, chief market strategist at B Riley-National, in a phone interview. That’s in contrast to 2013, when the Fed’s signal that it planned to begin scaling back an earlier asset-buying program sparked a messy bond market selloff that sent ripples through other markets. The Fed effectively spent months signaling that a tapering would come, a move that appeared to take the sting out of the announcement. Instead, the focus for investors is on a disconnect between the Fed and market participants on the outlook on interest rates. For his part, Powell gave some pushback to rising market expectations that rates will begin to rise in mid-2022, just after the Fed fully winds down its asset buying program if it sticks to the pace it outlined Wednesday. Powell said the Fed could be “patient” in raising rates. The Fed’s policy statement said officials still expect inflation pressures to prove “transitory,” adding language explaining why. But Powell also acknowledged that labor market improvements could proceed at a pace fast enough to justify rate increases by the second half of 2022. “Having started to probe whether central banks really can look through elevated pressures, today’s focus was always going to be on how much, if at all, Powell pushed back on market expectations for early and multiple hikes,” said Seema Shah, chief strategist at Principal Global Investors, in a note. “In the event, Powell maintained some flexibility by emphasizing the uncertain path for the economy — essentially sitting on both sides of the wall,” she said. For now, stock-market investors aren’t sweating rising expectations for rate increases, which have contributed to a flattening of the Treasury yield curve. That makes sense, said equity analysts at Wells Fargo Securities, in a note. They don’t expect the Fed to be aggressive in hiking rates because today’s inflation pressures are due largely to supply-side bottlenecks and other problems, rather than overly loose monetary policy. “Therefore, addressing inflation will require time, not monetary tools. We believe this is the concept that the market is latching onto, and why the equity market is rallying,” they wrote. The disconnect between the Fed and markets on rates remained on display. Traders continued to price in some chance of anywhere from one to four rate increases by the end of 2022, according to the CME’s FedWatch tool. That could set the stage for rough sailing over the long term. “I still think we will see the yield curve flatten and the dollar rise, thus tightening financial conditions over time, which will act as a headwind to stocks, said Michael Kramer, founder of Mott Capital Management