Market Insights

Federal Reserve Chairman Jerome Powell will answer a lot of questions in the Senate this week. But they all come down to one issue: Will he take away the punch bowl, or fill it up?

If you don’t know the lingo, we’re talking about interest rates. The old saying is that the Fed “takes away the punch bowl just when the party is getting started.” In other words, they tighten monetary policy at a time when everyone’s feeling great about the economy and stock market.

It looked like Powell would do exactly that until mid-November, but then he started an abrupt U-turn away from rate hikes. Ever since, policymaker after policymaker has morphed from hawk to dove. That means the Fed seems to be taking the unusual step of filling up the proverbial punch bowl instead of taking it away.

Instead of interest rates, talk now focuses on the central bank’s “balance sheet.” Simply put, “shrinking” the balance sheet is akin to raising rates because it means the Fed will pump less money into the system. They were trying to “reduce” or “normalize” it until recently. Any talk of ending the process is like “rum in the punch bowl,” similar to cutting interest rates.

At least two members of the Fed’s Open Market Committee said exactly that last week: James Bullard of St. Louis and Randal Quarles of the Board of Governors. Another, John Williams of New York, made a similar point by saying inflation expectations are too low.

Some other news events recently may bolster that view. U.S. consumer prices were unchanged last month, missing estimates for a 0.1 percent increase. Ditto for producer prices. Several reports out of Asia, including Hong Kong, Malaysia and Singapore, all painted a similar deflationary picture. That argues against rate hikes or balance sheet reduction.

Minutes from the last Fed meeting showed Powell’s already leading the central bank in this direction. So, what does it mean for investors if he highlights the message on Capitol Hill tomorrow and Wednesday? Here are some possible reactions.

Precious metals could be the first group to move. Gold futures (@GC) and silver (@SI) are two of the first places traders look because both commodities tend to rise on lower rates. There are also some big stocks and exchange-traded funds (ETFs) that could move in a similar direction, like Market Vectors Gold Miners (GDX), iShares Silver Trust (SLV) and Newmont Mining (NEM).

Global equities and emerging markets are another candidate because lower interest rates in the U.S. depress the dollar. Investors often respond to that environment by seeking growth in foreign assets. However, a lot of good news may already be priced into global stocks now that President Trump’s delayed punitive tariffs against China.

Finally, dovish monetary policy can increase the appeal of biotechnology and software stocks. The reason is that they tend to have low earnings yields (the opposite of price-to-earnings ratios). That can make low interest rates a positive for these high-multiple stocks.

In conclusion, a lot of attention will focus on Chairman Powell in the Senate this week. He and his cohorts have laid the groundwork for a shift toward gentler monetary policy. We’re not trying to make any recommendations or predictions, but hopefully this post helps you understand what’s at stake.