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As we all know by now, the Fed exited its September monetary policy meeting Wednesday and Chair Janet Yellen said that, in the Fed's view, the domestic economy is on solid enough footing to handle another rate increase as well as the Fed's plan to unwind its $4.5 trillion balance sheet. As she did this, she effectively brushed aside the fact the Fed's inflation target has yet to be realized, despite the herculean monetary policy efforts, and in the near term the economy is headed for a tumble following Hurricanes Harvey and Irma, and maybe more depending on how Hurricane Maria develops.
In recent days, we've seen several cuts to GDP expectations for the current quarter from the Atlanta Federal Reserve as well as several investment-bank economists with the general thinking Harvey and Irma trimmed roughly 1% off economic activity. With the bulk of the damage coming in September, including what we have yet to experience from Maria, we'll have a fuller sense of the trifecta's extent in October when we get the September data.
Given that, the market was caught off guard by Yellen's telegraphing the Fed is likely to boost rates one more time this year and targets three additional hikes in 2018. While sticking to the rate-hike forecast, Yellen said, "The median projection for the federal funds rate is 1.4% at the end of this year, 2.1% at the end of next year, 2.7% at the end of 2019, and 2.9% in 2020."
This means the next rate hike that is now likely to occur in December will be a quarter-point, and based on the Fed's forecast, the three targeted rate hikes in 2018 are likely to be of the same magnitude. Yellen again cautioned the Fed will remain "data dependent" in its thinking.
From our perspective, with a recovery that is increasingly long in the tooth (something that is not likely lost on Yellen and the Fed heads), we see the Fed looking to regain monetary stimulus firepower ahead of the next eventual recession. To be clear, we're not calling for one, just recognizing that at some point one will happen -- it's the nature of the business cycle. As we share that reality, we'd also note that historically the Fed has a very good track record of boosting rates as the economy heads into a recession.
As much as the Fed will likely try to avoid that and preserve Yellen's time as chair, it's different this time. Next month, the Fed will begin unwinding its balance sheet that bulked as a result of its quantitative easing measures. The Fed admits to "months of careful preparation," but let's be real here. This is unlike anything we have seen before as the Fed expects to boost interest rates further. Yes, the Fed will baby-step with its balance sheet as its targets selling no more than "$6 billion per month in Treasuries and $4 billion per month for agencies" in 2017. In 2018, however, those caps will rise to "maximums of $30 billion per month for Treasuries and $20 billion per month for agency securities." Given the Fed's balance sheet weighs in at a hefty $4.5 trillion, this is poised to be a lengthy process and we suspect that as well-intended as the Fed's thinking on this is, odds are there are likely to be some unintended consequences.
The question we continue to ponder is whether the economy is strong enough not to falter as the Fed ramps its selling while boosting rates. Even the Fed sees GDP falling from its 2.4% forecast this year to "about 2% in 2018 and 2019. By 2020, the median growth projection moderates to 1.8%." Not exactly good news for economically sensitive companies.
As we mull this forecast vs. the business cycle, we have to keep in mind the Fed is ever the cheerleader for the economy and tends to be optimistic with its GDP forecasts. We prefer to be Rhonda Realist vs. Debbie Downer or Cheery Charles, and when we triangulate the Fed's comments, we continue to think its underlying strategy is to re-arm itself for the next downturn.
As the dust from the Fed's comments settles, the targeted interest rate hikes will likely be a boon to banks like Bank of America (BAC) , Wells Fargo (WFC) and others, and could goose the housing market in the near term as fence sitters wade into the market. Granted, shares of Toll Brothers (TOL) , Lennar (LEN) and the like traded off Wednesday. But given low inventory levels that pulled forward demand ahead of higher mortgage rates, this is likely to boost demand in the coming months. With credit card debt topping $1 trillion, those expected rate hikes, should they emerge, will mean higher borrowing costs and greater interest payments that will sap disposable income. We see this as a headwind for consumer spending, and it's likely to accelerate the shift toward digital commerce as shoppers look to stretch their shopping dollars. We see that as positives for Amazon (AMZN) and United Parcel Service (UPS) shares.