Jay Powell, the chair of the Federal Reserve, announced a major change to monetary policy on Thursday, adding to what has become a remarkable period of activism in light of unprecedented economic conditions. In a widely anticipated move, Chair Powell announced that the Fed would no longer preemptively employ interest rate hikes in order to prevent future increases in inflation beyond its 2% bogey. Instead, it will wait for concrete evidence of price increases before taking action. The Fed chair also indicated that the institution would adjust its assessment of maximum employment to permit jobs growth to reach more workers. In the span of one speech, Powell introduced meaningful changes to how the Fed would seek to accomplish its “dual mandate” of price stability and full employment.
The Fed and other central banks have struggled with low inflation since the immediate aftermath of the Global Financial Crisis, leading to a search for new approaches that would help drive more sustained growth. However, the COVID-19 crisis introduced new immediacy to policy efforts, with the Fed cutting rates to zero, aggressively expanding its balance sheet to intervene across markets, starting with Treasuries and money markets, and later in corporate bonds and other sectors, and introducing its (still largely unimplemented) Main Street Lending Program to help support small and midsized businesses.
It’s a mark of today’s severe challenges and ultra-supportive monetary backdrop that the Fed’s shift from its previous decades-old inflation policy was expected and appears to have been readily accepted as part of the post-crisis framework. Moreover, unlike measures that might signal hidden systematic weakness, it really reinforces a commitment that seeks to maintain current momentum as the economy stumbles toward something resembling normalcy.
Push and Pull
The extraordinary actions by the Fed and other central banks have significant implications for markets, as it is now reasonable to assume the continuation of low rates for an extended period, accompanied by even lower or negative real yields. This posture has helped spur the rally in stocks and corporate credit over the last five months. Nevertheless, we continue to see economic conditions unfolding that are consistent with our Asset Allocation Committee’s base-case outlook for a U-shaped recovery. While business activity is resuming, it is doing so amid many challenges, including uncertainty as to the timing of full reopening, the impacts of second and third waves of infection, and ongoing economic damage often heavily weighted toward smaller businesses. At the same time, we’ve seen remarkable progress on vaccines and therapeutics—evidence of innovation and resiliency that could change the course of the recovery.
This push and pull is apparent in recent virus statistics and economic trends. Broadly speaking, the pace of new COVID-19 cases has been slowing in the U.S., but with significant variation across states; Europe, while more advanced in its recovery, has seen upticks that have impeded some reopening plans; Latin America continues to struggle to contain the disease; China has largely put the virus behind it, supporting economic momentum that could make it the only major economy to notch positive GDP performance this year.
Economic readings in the developed world have also been mixed. The most recent weekly U.S. unemployment reports have been tepid, while consumer confidence is low. PMIs have been disappointing in Europe but surprisingly strong in the U.S., where housing starts jumped 23% in July. Although the EU has seemingly achieved consensus on shared fiscal responsibility, the U.S. Congress remains deadlocked on a potential new round of stimulus.
Meanwhile, news on vaccines and therapeutics continues to be encouraging, if not definitive. Over 100 vaccines are in development, and advances to later stages of testing have been greeted favorably in the stock market, as has positive news on treatment. Although there is hope for vaccine approvals starting in late 2020 and early 2021, with broader availability next year, the timeline remains vague.
Balancing Offense and Defense
For investors, this mixed backdrop requires a thoughtful approach. In our view, you need to have a playbook ready for both offense and defense—to capitalize on opportunities as conditions improve, but also to remain vigilant for rising risks and changes in the current environment. We continue to anticipate a U-shaped economic recovery that doesn’t involve an immediate “all-clear” on the virus, but rather an environment where countries experience ups and downs both medically and economically but are increasingly successful on containment until effective vaccines become available.
Even as recent price records in the stock market suggest a V-shaped rebound, making us more cautious, some of the worst outcomes of an L-shaped recovery appear to have been mitigated by aggressive policy responses. Given our skeptical optimism, we prefer to be biased toward stocks of quality companies and those with clear sources of potential long-term or secular growth, while focusing on areas that are reopening and represent reasonable valuations. At the same time, we want to be prepared for volatility, which means balancing risk assets in portfolios, and benefiting from volatility-harvesting strategies such as equity index put-writing. Fixed income is an important aspect of our current positioning, with an orientation toward credit and a gradual extension of risk where appropriate.
Accommodative central bank policy, including the Fed’s latest maneuver, is an important and welcome pillar of the current recovery, but we continue to expect uneven progress against the virus and toward meaningful economic renewal. Extraordinary stimulus did not catalyze inflation or even dynamic growth in the post-GFC period. In our view, managing through the current environment will require a balance of opportunistic thinking and risk awareness. Having a playbook that prepares for multiple scenarios can help you manage in a highly uncertain world.
In Case You Missed It
- S&P Case-Shiller Home Price Index: June home prices increased 0.2% month-over-month and increased 3.5% year-over-year (NSA); no change month-over-month (SA)
- U.S. Consumer Confidence: -6.9 to 84.8 in August
- U.S. New Home Sales: +13.9% to SAAR of 901,000 units in July
- U.S. Durable Goods Orders: +11.2% in July (excluding transportation, durable goods orders increased 2.4%)
- U.S. 2Q GDP (Second Estimate): -31.7% annualized rate
- U.S. Initial Jobless Claims: +1,006,000 for the week ending August 22
- U.S. Personal Income and Outlays: Personal spending increased 1.9%, income increased 0.4% and the savings rate decreased to 17.8% in July
What to Watch For
- Tuesday, September 1:
- Eurozone Consumer Price Index
- ISM Manufacturing Index
- Thursday, September 3:
- ISM Non-Manufacturing Index
- U.S. Initial Jobless Claims
- Friday, September 4:
- U.S. Employment Report
Statistics on the Current State of the Market – as of August 28, 2020
|S&P 500 Index||3.3%||7.4%||10.0%|
|Russell 1000 Index||3.3%||7.4%||10.5%|
|Russell 1000 Growth Index||3.8%||9.7%||29.7%|
|Russell 1000 Value Index||2.7%||5.0%||-8.6%|
|Russell 2000 Index||1.7%||6.7%||-4.5%|
|MSCI World Index||2.7%||6.8%||5.8%|
|MSCI EAFE Index||1.7%||5.2%||-4.3%|
|MSCI Emerging Markets Index||2.8%||4.1%||2.5%|
|STOXX Europe 600||1.6%||3.9%||-4.7%|
|FTSE 100 Index||-0.6%||1.8%||-19.0%|
|CSI 300 Index||2.7%||3.3%||20.6%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||-0.1%||3.0%|
|Citigroup 10-Year Treasury Index||-0.8%||-1.6%||11.9%|
|Bloomberg Barclays Municipal Bond Index||-0.3%||-0.5%||3.3%|
|Bloomberg Barclays US Aggregate Bond Index||-0.5%||-1.0%||6.6%|
|Bloomberg Barclays Global Aggregate Index||0.1%||-0.3%||5.9%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.3%||1.2%||-0.7%|
|ICE BofAML U.S. High Yield Index||0.8%||0.9%||0.7%|
|ICE BofAML Global High Yield Index||0.9%||1.4%||1.8%|
|JP Morgan EMBI Global Diversified Index||-0.4%||0.4%||1.2%|
|JP Morgan GBI-EM Global Diversified Index||1.1%||-0.4%||-4.5%|
|U.S. Dollar per British Pounds||2.0%||1.6%||0.6%|
|U.S. Dollar per Euro||1.0%||0.6%||6.0%|
|U.S. Dollar per Japanese Yen||0.6%||0.4%||3.2%|
|Real & Alternative Assets|
|Alerian MLP Index||-1.2%||2.4%||-36.5%|
|FTSE EPRA/NAREIT North America Index||2.4%||1.9%||-16.7%|
|FTSE EPRA/NAREIT Global Index||1.6%||2.9%||-16.4%|
|Bloomberg Commodity Index||2.3%||6.5%||-9.3%|
|Gold (NYM $/ozt) Continuous Future||1.4%||-0.6%||29.7%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||1.5%||6.7%||-29.6%|
Source: FactSet, Neuberger Berman.