Stock and Bond Investors Get the Green Light from Fed

 Federal Reserve Chair Jerome Powell’s recent actions have demonstrated a keen interest in bolstering the confidence of stock and bond market bulls, going beyond his traditional mandate of maximizing employment while maintaining low and stable inflation. In 2022, Powell effectively removed excess premiums from the stock market, and he has since made it clear that the Fed will swiftly intervene to support the economy and investors at the first sign of trouble. Notably, in March 2023, Powell injected $400 billion in bank reserves following the failure of several major regional banks. Despite continuing with quantitative tightening (QT), Powell’s rhetoric has been decidedly bullish, hinting at future rate cuts and providing reassurance that the Fed stands ready to provide support when necessary.

Following a strong upward trend in the first four months of 2024, concerns arose that stocks might follow bonds into a significant correction. The market saw a 5 to 7% dip in major stock indices in April, prompting the Fed to adjust its approach. Recognizing that inflation had not decreased sufficiently to warrant interest rate cuts, the Fed opted to reduce the draining of banking system reserves by 58%, a move that was well received by investors who were on the brink of pushing stocks and bonds to multi-month lows in May.

Despite a modest 3-month uptick in inflation, Powell’s indications of a less restrictive monetary policy, coupled with his forecast of no rate hikes and a potential rate cut, provided a stabilizing effect on both the bond and stock markets. Investors are currently enjoying what appears to be a “Goldilocks economy,” characterized by decreasing inflation rates alongside rising earnings and GDP, all against a backdrop of full employment, record corporate share buybacks, and consistently surpassing corporate profit expectations.

While business earnings have historically outperformed forecasts, current profits are exceeding expectations by a significant margin. Should interest rates and inflation remain stable or decrease further, this trend could persist. The only element missing for the Bulls to achieve new record highs has been a sense of apprehension to overcome a looming correction. Although a climax selling bottom in May would have been preferable after the April market decline, the Fed’s optimistic announcements regarding monetary easing on May 1st have been perceived as yet another vote of confidence for the stock market. While some additional market weakness to eliminate excess premiums would have been welcomed, our expectation remains for new record highs to be reached in the July-August timeframe.

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