Stocks bounce higher after Fed holds off on rate hikes

US stocks finished higher on Wednesday, after the Federal Reserve left interest rates unchanged and said it didn’t expect to raise interest rates this year. Fed Chairman Jerome Powell said the central bank expects any increases in inflation over the summer months to be temporary — and not concerning for its monetary policy at the moment.

Meanwhile, the Fed also upgraded its consensus outlook with expectations for higher economic growth and lower unemployment.

Stocks jumped in response, and the Dow closed at a new all-time high and above 33,000 points for the first time ever. The index closed up 0.6%, or 189 points.

The S&P 500 also rose to a new record high, finishing up 0.3%.

The Nasdaq Composite closed up 0.4%.

Before the pandemic, the Federal Reserve was focused on whether interest rates were too low. Have its views changed?

"We're committed to giving the economy the support it needs, as quickly as possible, until it returns to maximum employment and price stability," said Fed chair Jerome Powell.

"To the extent that raises other questions, we think it’s absolutely essential to maintain the strength and stability of the financial system," he added.

He pointed to the longest economic expansion in US history, which lasted 10 years and eight months until the pandemic cut it short. Rates remained at zero for 7 of those years, and they never went above 2.4% during the period of expansion.

"During that time the US didn’t see excess build-up of debt or a housing bubble," he said. "That doesn’t mean we are ignoring these possibilities."

One reason for the expansion was the low-rate environment, he said. While he acknowledged there is "a connection between low rates and financial instability," he noted that "it's not quite so clear."

Asked whether the Fed is planning to extend restrictions on share repurchases into the second quarter, Fed Chairman Jerome Powell didn't have much to share.

“We haven’t made a decision," he said, adding that it will be several weeks before any plans are announced and “I won’t foreshadow that here today.” 

Banks increased their level of capital and reserves throughout 2020, he noted, and the December stress test showed banks are in a strong position. The Fed is currently in the middle of its 2021 stress test, Powell added.

The Fed offered a rosy outlook about jobs: A return to an unemployment rate below 4% next year and 3.5% in 2023. That's back to "full employment" and at the historic lows we saw before the pandemic. (We're at 6.2% now.)

But...

The unemployment rate doesn't tell the full story, and Federal Reserve Chairman Jerome Powell said the Fed isn't going to declare victory just yet.

"No matter how well the economy performs, unemployment will take quite a time to go down, and so will participation," Powell said.

In particular, Powell lamented the rapid rise in unemployment among minority populations, noting they need extra support from the government and policymakers to help return them to the historically low unemployment they enjoyed before the pandemic.

"Not yet," said Federal Reserve Chairman Jerome Powell.

And boom goes the dynamite.

Stocks surged after Powell said at his press conference that it's "not yet" time for the Fed to wind down its bond purchases that have been supporting the bond market, keeping yields lower, debt cheaper and corporate profits higher. That cycle, which has been in place for a year, has sent the stock market on its current record tear.

The Dow was up 200 points, or 0.6%. The S&P 500 rose 0.3% and the Nasdaq, which had been down moments earlier, zoomed into the green -- up 0.4%.

Bond investors can breathe a sigh of relief ... for now.

The Fed has been supporting the bond market by purchasing hundreds of billions of dollars of Treasuries. With the Fed anticipating much stronger-than-expected economic growth thanks to stimulus, vaccines and other factors, some on Wall Street wonder whether the Fed would start winding down those purchases.

"Is it time to start talking about talking about tapering?" Reuters' Howard Schneider asked Federal Reserve Chairman Jerome Powell at his press conference.

"Not yet," Powell said to a chuckle. "We've said that we would continue asset purchases at this pace until we see substantial further progress. And that's actual progress, not forecast progress."

Doing his best impression of a broken record, Federal Reserve Chairman Jerome Powell said inflation will tick up because of the $1.9 trillion stimulus bill ... but don't fret: This ain't the 1970s, when runaway inflation led to an economic crisis.

Powell noted, "The economy is a long way from our employment and inflation goals." So the Fed isn't taking its foot off the gas just yet.

Here's what $1.9 trillion of stimulus can do for you: The Fed now expects the US economy to grow 6.5% this year, up from its previous forecast of 4.2%.

Some of that growth is an organic return to form as hundreds of millions of Americans get vaccinated and people begin to return to normal life. But the sugar rush from stimulus will juice the economy way more than initially forecast -- just what Fed Chair Jerome Powell had long been asking Congress for.

One key number from the Fed's policy statement today that investors will be staring at for a while: 2.4%.

That's the 2021 inflation expectation, up from the Fed's previous forecast of 1.8%. To say investors have grown concerned about inflation is an understatement. It has become the top concern on Wall Street, according to a Bank of America survey. Yup, more than Covid.

But the Fed doesn't seem too concerned about inflation today — and neither does Wall Street, for the moment. The price spike could be temporary, a one-off blip from the government handing out free money to 85% of Americans.

Although the Fed anticipated the US economy would make "substantial further progress" by the end of the year, it said nothing about tapering its government bond purchases, which have been propping up the Treasury market. If the economy gets substantially better by the end of the year, though, the Fed may wind down its bond-buying, potentially sending yields higher and making Wall Street worriers even more concerned.