Can the Fed Save the Stock Market Again?

Thursday was a turbulent day on Wall Street, with stocks seeing a lot of movement. After an initial loss, major market benchmarks clawed back most of what they'd lost, with the Dow Jones Industrial Average (^DJI 0.40%) climbing into positive territory briefly. Yet shortly thereafter, the downturn continued, and that sent the Dow down along with the S&P 500 (^GSPC 1.02%) and Nasdaq Composite (^IXIC 2.02%).

Today's stock market

Data source: Yahoo! Finance.

Many market participants attributed today's declines to the latest comments from the Federal Reserve. Although the press conference from Fed chair Jerome Powell started before the market closed on Wednesday afternoon, it appears that it took a global reaction to the implications of the Fed's position to persuade U.S. investors that there could be something to worry about.

The Federal Reserve Building. Image source: Getty Images.

Low rates as long as it takes

The biggest takeaway from Powell's comments is that the Fed remains committed to keeping interest rates effectively at zero as long as is necessary to support economic activity. As the central bank's members currently see it, that means not doing anything with rates until more than three years from now, at the end of 2023.

The Fed tried to set out simple standards for investors to weigh in determining when rate hikes might once again be on the table. First, it wants to see the labor market get back to its former healthy condition, with unemployment levels reflecting structural maximum employment constraints. That's clearly not the case right now, with tens of millions of people having lost their jobs during the coronavirus pandemic.

Also, the Fed wants to see inflation return to the economy before it'll be comfortable raising rates. The central bank kept its 2% benchmark, but it wants to see the inflation rate set to top that level at least for a while before pulling the trigger.

Not as clear as investors wanted

Upon further reflection, however, markets didn't find the Fed's statement or Powell's comments all that comforting. The fact that the Fed might well essentially do nothing with interest rates for years suggests a level of powerlessness that bodes ill for confidence in future monetary policy.

Yet the bigger concern is that the statement underlines the limitations of monetary policy. All along, the Fed has urged Congress and the White House to take measures to provide fiscal stimulus. Although Washington obliged early in the crisis, there's been increasingly tense debate about any further extensions of stimulus measures.

In particular, there's only so much that the Fed can do to help encourage greater employment. Fed officials would like to see the unemployment rate drop back to roughly 4%, but that could definitely take years. Meanwhile, wrangling over jobless benefits is taking away some certainty from the labor market, as workers try to figure out whether they can count on support from state and federal government agencies or will have to make do on their own.

Perhaps most importantly, investors should remember that even with the recent abrupt pullback, the stock market is still doing well. It's only in the context of the amazing bull market rally from March's lows that these declines look troubling at all. That suggests that long-term investors are actually more confident about the market than ever -- and that the Fed might actually be doing all the right things to save markets from a structural collapse.