The month of September is often a challenging one for the stock market but this year the market sailed through the month unscathed. That was in spite of the many events taking place which in the past would have rattled the market.
The consensus at the September Federal Reserve meeting was to hold interest rates steady. The projection of annual GDP growth for the next couple of years was that it will run below 2%. The message was one of economic weakness even though Chairman Yellen said the economy is performing well. There is obvious concern that raising rates at the pace published a year ago could stall the economy. They did leave the door open to one more increase this year and that likely in December. The initial reaction of the stock market was to pull back, but by end of the trading day the losses were recovered.
What the Federal Reserve Board did decide is to begin unwinding the excessive bond and mortgage backed security portfolio which was built up in the years following the 2008 financial crisis through three quantitative easing programs. Beginning in October the federal government will reduce its U. S. Treasury holdings by $10 billion per month by reducing the amount it reinvests. Quarterly that amount will be increased by $10 billion until it reaches $50 billion a month by the last quarter of 2018.
While an interest rate increase impacts short term money, reducing the bond portfolio will impact the longer end of the investment spectrum. It will likely decrease the price of Treasuries as supply increases thus raising the long term interest rate. It will take some time for a noticeable increase to be achieved. Forecasters expect the 10 Year U S Treasury yield which is tied to mortgages and longer term debt to move up to about 3% by the end of 2018.
How will this impact the stock market? There are many factors influencing the price of stocks, but in general higher long term bond rates is negative for stocks. It will depend in part on the reaction internationally. If foreign governments replace the demand, that could temper interest rates.
At the end of September the President’s proposed tax overhaul was introduced. It has been decades since Americans have seen such major changes in the tax code. It proposes simplification by doubling the standard deduction for individual taxpayers in exchange for fewer itemized deductions and reducing tax brackets to 3 instead of 7. It also calls for reductions in the business tax to make U. S. companies more competitive world-wide. The missing piece is the detail on what this will cost. There will be plenty of debate but in the end if Congress will reduce taxes on individuals and businesses, it will put more money into the economy which should be a positive for the stock market.