US Economy Faces Shakier Outlook As Fed Sounds More Downbeat Tone

The latest decision from the two-day FOMC Meeting came as little surprise to financial markets anticipating little in the way of action on interest rates and broader policy. However, it does not mean the decision lacked importance. If anything, the contents of the FOMC Statement produced a sense that even the best laid plans go to waste. Although inflation “will” get back to the 2.00% targeted by the institution over the medium-term, the context of the decision nevertheless highlighted the more dovish leanings of the Federal Reserve.

With more questions than answers following the latest FOMC decision, the reaction in financial markets has been palpable. However, from an economic perspective, the Fed is just starting to see the impact of its December decision to raise interest rates. Between faltering housing fundamentals and potential labor headaches, the new US Administration will find it difficult to live up to the hype exhibited by financial markets over the last few weeks. Considering the backdrop, new highs in equity benchmarks may be a little premature relative to actual economic conditions.

Inflation Remains Worrisome

Although the headline inflation figures released late last month seemed to suggest that consumer prices were back on the upswing, helped in large part by resurgent energy prices and rising rent costs, the Fed’s perspective proved markedly different. According to the statement from the decision, the Fed believes that “market-based measures of inflation compensation remain low.” In simpler terms, the Fed is largely unimpressed by the momentum in consumer price gauges despite taking a more hawkish viewpoint with the belief that inflation will rise back towards the 2.00% target. Headline CPI did print at 2.10% during December, though the more closely watched core PCE inflation is currently at 1.70%.

Besides the fact that core inflation, which traditionally strips away the more volatile food and energy components, remains below the Fed’s target, other areas of the economy have been impacted by higher rates. While it may be viewed as still too early to tell whether higher rates are dissuading potential buyers, both existing home and new home sales figures for December missed expectations by a wide margin. Furthermore, rising pending home sales suggest that buyers may be having a change of heart as the outlook for mortgage rates indicates rising costs. It is easy to cheerlead the most recent S&P Case-Shiller home price index at a record high as proof of a stable housing market, but the figure is from November, before rates were last hiked.

It will take at least another few months for the Federal Reserve to measure the impact of its actions on the American economy, creating a sense that only two rate increases will be possible during the calendar year. Fed Funds futures, which are traditionally used to measure the likelihood of action from the Federal Reserve, indicate that the earliest markets are pricing in a rate hike is currently June. March is off the table, with the lack of hints from the Fed on a more solidified timeline adding to the perception that tightening policy further will be heavily data dependent, adding to the sense of market anxiety.Although equities have not necessarily reflected this growing uncertainty as significantly thanks to a weaker US dollar which is spurring upside in valuations, the risk factors are stacked against continued gains.

Equities Retreat as Fed Fails to Inspire Confidence in Outlook

Despite being quick to highlight improved sentiment amongst businesses and consumers, the Fed decision was not received with the same degree of optimism by financial markets and Wall Street. The evidence was the modest selloff in equity benchmarks that followed the decision. After reaching a new record high last week, the S&P 500 has found itself under renewed downward pressure, trending mostly flat to slightly weaker over the last few sessions. With the Trump reflation rally behind markets and the prospect of infrastructure stimulus rapidly vanishing, the upside prospects for equities are rapidly dimming. From a technical perspective, the emergence of several factors could add to the downside risks.

What Binary Options Traders Should Watch For

The key factors to watch in the weeks ahead are the trajectory of the US economy. With the S&P 500 serving as a leading indicator of economic activity, any downturn in the index could suggest a worsening of the outlook and vice-versa. Furthermore, any hint that March could be a “live meeting” for the Federal Reserve could suggest a rate hike coming sooner rather than later. With interest rate moves being historically negative for stocks and hints of hawkishness sinking sentiment, any raised possibility of a change in policy could be bearish for stocks. While infrastructure spending, stimulus, and tax cuts are viewed as positive tailwinds, absent developments on these fronts, risks for stocks may continue to be skewed downwards.