From surveys on small business confidence to reports on global freight costs, there is an almost limitless supply of data points that analysts can use to try to predict future economic growth and, subsequently, stock prices. However, the one factor that many market observers will claim dominates, especially recently, the direction of equity indices is the sentiment of the central bankers at the Federal Reserve. Following the worst December for domestic stocks since the Great Depression, the Fed indicated to the market that it could slow down its “hawkish” monetary policy. Future increases in the federal funds rate, its benchmark short-term interest rate, could be delayed and further reductions in its bond portfolio could be pushed back. This signal helped boost equities at the beginning of 2019 despite weakening global economic data and underwhelming domestic corporate earnings reports.
The Fed continued to provide assistance to stocks last week with the release of the minutes from its latest monetary policy meeting. These notes indicated that not only will the Fed slow down its current path, it would implement “dovish” policy moves if turbulence returns to the equities market. Instead of slow increases in rates, there could be rate cuts.
One major concern with this policy trajectory is that it leaves the Fed constrained in its ability to help the domestic economy when it hits an especially rough patch. As the chart below shows, during the last three recessions the central bank lowered the federal funds rate significantly in an attempt to encourage business investment by decreasing the cost of borrowing money. In fact, over the last thirty years, during recessionary periods the benchmark short-term interest rate was lowered on average by -5.68% to support economic growth. With the current effective federal funds rate at 2.40%, the Fed wouldn’t be able to provide the same magnitude of jumpstart as it has done in the past.