The Fed, inflation and Washington proposals

Anthony Saglimbene, Global Market Strategist — Ameriprise Financial

As of September 20, 2021

The market tone has been somewhat cautious among investors in September, as stocks have seen few new catalysts to motivate buying. But after a strong first eight months of the year, investors should expect a modest pause in stock momentum. Stock performance is historically weak in September, and we believe investors should look forward to the fourth quarter, as equities tend to perform well then.

Vaccines remain highly effective against COVID-19. As a result, we believe the stock market and U.S. economy could remain strong. Corporate profits are expected to grow through the rest of the year, and we believe the market could look through the Federal Reserve’s eventual formal announcement to slightly reduce its monthly bond purchases.

However, peaking growth and slower reopening momentum because of Delta have investors on guard. Lingering supply chain disruptions and slowing leisure activity have dominated corporate headlines and could negatively affect sales and margins in the third and fourth quarters. Also, the path forward for additional fiscal stimulus looks complicated, and markets may be bracing for a debate over the federal government's budget and debt ceiling in the coming weeks.

Absent a development that materially alters the growth trajectory, we believe an eventual market correction would be an opportunity to buy stocks at better prices.


Federal Reserve tapering

We believe the Federal Reserve should announce its taper timing. In our view, investors have primarily discounted the expectation that the Fed will soon announce its plans for tapering bond purchases in the next few Federal Open Market Committee (FOMC) meetings.

While the weaker-than-expected August nonfarm payrolls report may have taken a September announcement off the table, in recent speeches several FOMC members have pointed to taking action this year. Currently, the Fed is buying $120 billion a month in government and mortgage-backed securities. Most expect the Fed will start its taper strategy by reducing purchases by $15 billion a month, beginning late this year or early next year. In our view, the Fed has successfully prepared markets for a taper. All that’s left now is for the Fed to announce its decision.


Inflation pressures

On the inflation front, there are small signs that the pace of higher prices in the United States is beginning to moderate from peak levels in the spring and early summer. On a month-over-month basis, consumer prices in July and August dipped lower, though they remain at elevated levels on a year-over-year basis. On the producer side, prices finally dropped lower in August versus July levels but remain elevated on a year-over-year basis.

Pandemic challenges, continued supply disruptions, sourcing issues and strong demand contribute to higher inflation levels around the world today. And while prices across autos, energy, food and some service-related areas could see the pace of growth slow over the coming months, inflation pressures that linger for longer than expected could weigh on economic growth with time.


Washington proposals

Over the coming weeks and months, Congress will need to raise or suspend the federal debt ceiling, find a path forward on a bipartisan infrastructure bill, work through the details of a reconciliation bill for Democratic spending priorities and address implications for taxes.

As a result, we believe markets could see periods of short-term volatility due to budget and deficit spending debates. Recently, U.S. Treasury Secretary Janet Yellen said that if the debt ceiling is not raised or suspended, the United States could default on its obligations sometime in October.

From a market perspective, investors will likely be most interested in a reconciliation bill and the potential impact on higher taxes for corporations and individuals. Proposals in the House of Representatives point to higher tax rates across a range of areas, but, thus far, they remain starting points for discussion.

We believe it is highly likely the debt ceiling will be raised or suspended, and a continuing resolution will ensure that federal government agencies continue to operate. However, investors should be aware that taxes — including the capital gains rate — could increase for certain income levels if a reconciliation bill is passed into law.

While markets have a long track record of looking through changes in fiscal policies, tax changes can create periods of short-term stock price volatility, especially when the policy details remain fluid — as they do now. Regardless of how tax laws may or may not change, investors should continue to follow a properly diversified portfolio with quality assets and remain confident that capital markets will eventually refocus back to longer-term prospects for growth.


Underlying market and economic fundamentals remain strong

Through much of the summer, equity prices have looked through slowing growth trends, largely ignored the Washington and Federal Reserve activities and viewed pandemic-related issues as temporary. As a result, we believe markets have become complacent about some of the potential risks to growth, including lingering inflation pressures. Therefore, investors shouldn’t be caught off-guard if stock prices ultimately start to reflect a less rosy outlook at some point.

That said, if current trends remain, some better-than-expected economic data could keep sentiment skewed to the upside through year-end. Investors could continue to look through these concerns and remain confident the longer-term outlook for stocks remains positive.

Indices total return % year over year chart

S&P sectors calendar year 2021 returns bar graph

Data source for indices and sector graphs: Morningstar Direct, as of September 13, 2021.

These examples are shown for illustrative purposes only and are not guaranteed. Past performance is not a guarantee of future results.