Market shows no panic over possible cut in US stimulus; understand why

Even as the Federal Reserve prepares to withdraw some of the stimulus measures it implemented when the Covid-19 pandemic paralyzed the US economy in March 2020, stocks continue to reach new highs in the American purse.

Fed Chairman Jerome Powell is expected to speak about plans to begin scaling back bond purchases at a Wednesday afternoon press conference.

The Fed might even suggest that interest rate hikes could also be planned towards the end of next year. Rates have been zero since March 2020.

In futures trading, traders are estimating a 33% chance of at least two interest rate increases by the end of 2022 and a 25% chance of three rate increases by January 2023.

So why don’t investors look stressed, as they were when former Fed Chairman Ben Bernanke hinted that the Fed would soon slow down bond buying in 2013?

At that time, stocks fell sharply and long-term Treasury yields soared.

This time, everyone knows the reduction is coming. Powell has been suggesting for months that the economy is improving and may no longer need as much support from the Fed.

That’s a big difference from nearly a decade ago, when Bernanke took the market completely off guard when he first suggested a taper.

“The Fed has been signaling the reduction for some time. They’ve learned a lot and they don’t want to make the same mistake twice,” said Whitney Sweeney, investment strategist at Schroders.

No crisis as long as the Fed follows the manual

Even if Powell doesn’t announce the abatement schedule, the market may simply throw a tantrum anyway, Sweeney said. That’s because investors want evidence that the Fed is actually confident enough in the recovery to be able to withdraw stimulus and see how the economy is doing on its own.

“A tantrum is unlikely to happen. But we have to wait and see how Powell discusses the rate hike cycle,” said Jim Caron, chief strategist at Morgan Stanley Investment Management.

Caron said the Fed also seems willing to allow inflation to rise further for now, in hopes that prices will start to fall next year as supply chain and labor market disruptions begin to ease. .

That means the Fed would likely try to raise rates gradually, rather than acting aggressively to curb fears of hyperinflation.

corporate taxes

The market also appears to be growing confident that corporate taxes may not go up much – or even rise – anytime soon. That would also be a gift to the Fed.

Opposition to President Biden’s plan to raise the tax rate for companies of top moderates on Capitol Hill, namely Democratic Senators Joe Manchin and Krysten Sinema, could condemn any chance of a significant increase.

“I don’t see an increase in corporate tax rates coming now. There are a lot of fires in Washington,” said Dan Genter, CEO and chief investment officer at RNC Genter Capital Management.

Powell, who, like most Fed members, follows the mantra that the central bank is apolitical, would likely not comment on any tax proposals. But market watchers think the Fed would have more leeway to cut and raise rates if it didn’t have to worry about investors reacting to the prospect of higher taxes hurting profit margins.

“The Fed generally doesn’t bet on political outcomes,” Caron said. “But it will react to Biden’s agenda going forward as soon as the information is out.”

In other words, Powell and other Fed members will be able to breathe a big sigh of relief if the DC stalemate prevents Biden from getting what he wants.
“In theory, the Fed is independent,” Sweeney said. “But higher taxes would have been a headwind. For sure.”