foxex: Fed's Projections Meet Market Expectations

Chart Advisor | Focus on the Price

Wednesday, March 20, 2019

1. Fed avoids shocking the market

2. Interest rates fall with growth outlook

3. Returns across the market may be uneven

Major Moves

The last time we received the Fed's forward-looking estimates for interest rates and growth was last December. At the time, the median estimate for the overnight interest rate by the end of 2019 included 2 more hikes in 2019. Since then, traders had shifted to an assumption that there was zero chance for a rate hike and a 25% change for a rate cut by the end of the year as growth has slowed in Asia, Europe, and much of North America.

The risk today was that the Fed would not match the market and leave their own estimates higher than expected. Fortunately, the Fed's new projections were much lower and indicated no rate hikes for 2019 when they were updated this afternoon. Investors no longer need to worry that the Fed will cause a market decline in the short-term which should be good for investors in both bonds and stocks.

However, a more dovish stance isn't equally good for all stocks. Dividend payers should get a boost, but companies that earn interest will probably take a hit. For example, as you can see in the following chart, Bank of America (BAC) reversed its recent breakout and was sucked back into its January-February trading channel. Other interest rates sensitive groups like insurance companies, brokers, and investment managers will probably also take a hit after today's announcement.

S&P 500

As I have mentioned in previous Chart Advisor issues, Fed-days are prone to an odd kind of whipsaw. Over the last 11 years, whatever the market does in the first 10-15 minutes after the announcement is reversed by the end of the session 75% of the time. While this is interesting, I don't think anyone besides day-traders could really take advantage of the pattern.

What is more important to investors is whether today's whipsaw is predictive for where the market will be in 10-30 days. In the studies I have conducted, there is a mild bullish bias 30-days after the Fed announcement if the initial reaction was positive. If the initial reaction was negative, (such as after an unexpected rate hike,) there is a slightly negative bias. Its not a strong enough pattern to justify big changes to an investment strategy, but history suggests that traders should still expect a mild bullish edge through the middle of April.

Read more:

What is a Whipsaw?

How to Become a Day Trader

Three Securities to Watch Ahead of the Fed

Risk Indicators - Long-term Interest Rates

From a risk perspective, one issue that I remain very concerned about may sound a little contradictory considering today's news which is falling interest rates.

To be clear, what the Fed did today was lower expectations that the overnight rate or the Fed Funds Rate would be raised in 2019. This is different than longer term interest rates like the yield on the 10-year treasury note. Sometimes these interest rates move the same direction, however, lately, they have been moving differently which is a potential source for concern.

For example, following the Fed announcement, and Chairman Jerome Powell's comments, the yield on the 10-year treasury dropped more than 3%. The 10-year yield is closely tied to other consumer interest rates like mortgages, credit cards, car loans, and student financing; however, while this may sound like a good thing, it tends to indicate a lack of confidence around growth.

The problem is that investors who provide the capital to be borrowed are not incentivized to do so if they can only earn very low interest rates. Falling rates could also be the result of low borrower demand. Either scenario isn't a good indicator for growth. As you can see in the following chart, the 10-year yield (TNX) dropped out of its symmetrical triangle pattern on March 8th and the decline following that signal was accelerated today after the Fed announcement.

What this tells us is that the market isn't ready to collapse, but returns could be very uneven from one industry group to the next. Finance and tech usually lag while interest rates are dropping while income stocks (utilities, consumer staples) and retail would normally do better. Real estate stocks should also benefit from lower interest rates, but the reaction could be more unpredictable in that group.

Small-Cap Bear ETFs Look to Be Waking From Hibernation

6 Stocks With 'Pricing Power' Poised To Race Ahead of Market

Bottom line: Stocks still good, but outlook is getting hazy

I don't expect the Fed's actions to change much about the market in the short-term. They probably dodged a potential bullet by lowering their forecasts for the Fed Funds Rate, but investors are much more concerned about growth than plus or minus 25 basis points in the overnight funding rate. That is where longer-term interest rates can provide additional direction. Right now, the outlook isn't bearish, but it is getting a bit cloudy. The Fed did what it could today to reassure investors, but growth in Europe, Asia, and North America is still slowing which makes the latter half of 2019 more of an unknown.

FedEx Falls to Support After Unexpected Guidance

Learn the basics of investing

How can we improve the new Chart Advisor? Tell us at chartadvisor@investopedia.com