foxex: Fed Raises, Markets Sink

The Market Sum | INVESTOPEDIA

Insight after the bell

By Caleb Silver, Editor in Chief

Wednesday's Headlines

1. Fed Raises Rates and Markets Scream

2. Chart of the Day: It's All in the Dots

Markets Close

Dow
23,323.66 -1.49%

S&P
2,506.96 -1.54%

Nasdaq
6,636.83 -2.17%

VIX
25.58 0.00%

INV Anxiety Index
97.98 Low Anxiety

US 10-Yr Yield
2.778 -1.66%

Fed Raises Rates and Markets Scream

Everyone knew the Federal Reserve would raise the overnight lending rate by 0.25% today, but there may have been more than a lingering hope that Chairman Powell and the Federal Open Market Committee would take a 'wait and see' approach to further hikes in 2019. Unfortunately, investors didn't get that from Powell at his press conference this afternoon. The Fed Chairman indicated that rates are still lower than the 2.9% that the FOMC considers to be 'neutral.' In other words: expect at least two more hikes in 2019.

Here's our story following the FOMC's press conference.

That was all investors needed to hear to hit the 'SELL' button with both fists, driving the DJIA and the S&P 500 to their lowest levels of the year. It was the fourth rate hike this year, but this one hurt the most given that stocks are still recovering from more than a few bodyblows since September.

Everyone, from President Trump to major money managers, has been imploring the Fed to back off from its hawkish policy as U.S. markets slide into correction territory from record highs in September. But Powell would not be swayed, and rightly so. It is not the Fed's job to create monetary policy that keeps the bulls running. We know that interest rates will continue to rise next year, and even though there will likely be only two rate hikes, investors aren't satisfied.

Today's chart shows how merrily we were skipping along until 2 PM when the Fed dropped its statement about the rate hike. Investors sold immediately, reconsidered, and then really sold during Powell's press conference. That didn't go over well, even though Powell's responses told the tale of a strong U.S. economy, albeit with lower inflation than the Fed would like. The Fed is like Goldilocks... it likes an economy that grows fast but not too fast, inflation at around 2 - 2.5%, and low unemployment. The U.S. economy is in the Goldilocks zone, but the U.S. stock markets are in an ice cold bowl of porridge.

Why it Matters:

The Fed can't tinker with monetary policy to prop up the stock market. It's not its mandate and it would be a dangerous and slippery slope if it started playing that game. The agency can take financial markets into consideration as a data point, and Powell acknowledged that they did, commenting on the recent volatility in financial markets. But markets have been volatile for a host of reasons — trade wars, a slowdown in corporate earnings, and extended valuations for stocks. Interest rates are still historically low. Zoom into the chart below to see the St. Louis Fed's history of the federal funds rate and you'll get the picture.

Still, investors don't care about history. They care about the future. If the future looks like one with rising rates that could curb lending, borrowing, investments in R&D, and anything that would impinge corporate profitability, they will spit it out. Consumers should care about rising interest rates because it impacts every loan we have. Credit cards, auto loans, student loans, mortgages, small business loans... they are all based, in part, off of the federal funds rate. If you have a variable or adjustable loan, open your mail from your lender in the next few weeks and you will see a notice that it is raising your interest rates due to increases in the federal funds rate. That could keep consumers from spending and buying homes and cars, which will certainly weigh down stocks in the future. That, my friends, is how the economy and the stock market are connected.

What's Next:

It would be a Christmas miracle if markets bounce back from the recent selling and end 2018 flat. It's hard to see that happening and it's pointless to dwell on it. U.S. markets are in a downtrend, no matter how you look at it. We brought up the record amount of selling of stocks and equity ETFs in a note last week. Some of that is the kind of seasonal selling we typically see towards the end of the year, but some of it is just raw pessimism. We don't know how much, but the bearishness is palpable. Market highs and lows are always extreme. You need to protect yourself from both by sticking to a strategy that doesn't expose you to too much risk in any market. Give yourself that gift.

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Chart of the Day: It's All in the Dots

December FOMC Dot Plot

September FOMC Dot Plot

As we've noted, the Federal Reserve raised the Fed Funds benchmark interest rate by 25 basis points to 2.25 - 2.50% at the conclusion of Wednesday's FOMC meeting. As was also expected, the Fed signaled slower rate increases for 2019 and beyond through its so-called "dot plot," which details FOMC members' interest rate projections. In its last meeting in September, the median dot plot outlook was for three rate hikes in 2019. Now, the median outlook has been brought down to two hikes next year.

The first dot plot shown above is the latest one from today. The median projection now lies around 2.9% for the end of 2019. In a previous FOMC meeting in September, though, the median was closer to 3.1%, as shown on the the second dot plot. This signals a clear slowing of rate increases going forward, making today's Fed decision a "dovish rate hike," which was mostly expected by investors. However, judging by the market's severely negative reaction to the decision at the close, it may not have been dovish enough.