- Low rates and ample liquidity continue to support market gains.
- The Federal Reserve signaled that rates would remain low, emphasizing the benefits of full employment in its policy framework update.
- The economy bounced back faster than expected but remains dependent on fiscal stimulus.
Volatility remains elevated in the run up to the election.
Despite the unwelcome return of volatility which saw the S&P 500 decline almost 10% from its early September peak, markets ended up for the quarter. The S&P 500 returned almost 9% in the period, and commodities were up over 7%. Real Estate Investment Trusts (REITs), up only 1.4%, remain under pressure as this sector is vulnerable to the continuing pandemic. Investors remain convinced that the Federal Reserve (Fed) will continue to provide a backstop to credit markets. High grade investors easily absorbed record corporate issuance totaling more than $1.5 Trillion so far this year. High-yield and investment grade corporate bonds outperformed treasuries by 4.37% and 1.40%, respectively, as spreads tightened during the quarter. Interest rates traded in a fairly narrow range with most points on the treasury curve within 5 basis points of where they were in June.
The Fed unveiled its new policy framework while reiterating its goals of maximum employment and price stability. The Fed’s new guidance indicates that rate hikes won’t happen until realized inflation reaches 2%, and inflation is on track to moderately exceed 2% for some time. Policymakers want to see enough job growth to fully absorb labor slack, even if that means the economy runs “hot” before raising rates. This reflects the view that the benefits of job gains are distributed more broadly as the economy approaches full employment. The Fed’s move towards a more flexible inflation target wasn’t a surprise. Investors believe that the new policy factors in a 1-2% overshoot of the 2% target to ensure the economy reaches full employment. Real rates are likely to remain depressed in this scenario.
Even with a fiscal tailwind, it will take some time for the economy to recover.