Fed's Next Rate Move Just One Highlight with Apple Earnings, More Jobs Data Ahead

(Monday market open) Investors have their pick of news this week, with Apple (NASDAQ:AAPL) reporting on Thursday just a day after another interest rate decision by the Federal Open Market Committee (FOMC) and a day before the April jobs report.

There’s not much mystery associated with the FOMC this time, as the market’s baked in about a 90% chance of another 25-basis-point rate hike. What comes after that for rates is where the real drama lies.

April ended up mixed for the market, with small-cap stocks falling about 2% but the S&P 500® index (SPX) rising about 2%.

• The 10 Year Treasury Yield rose 2 basis points to 3.47%.
• The U.S. Dollar Index ($DXY) is a bit lower at 101.69.
• The Cboe Volatility Index® (VIX) futures are at 16.36.
• WTI Crude Oil (/CL) fell to $75.11 per barrel.

The VIX is at its lowest level since late 2021, which could indicate a “risk-on” sentiment in the market. The equity market is acting as if all is well. But if you look at the inverted yield curves, assets and liabilities at commercial banks, the risk from commercial real estate, and lack of loan growth, credit tightening appears to be taking place.

The big weekend news concerns First Republic Bank (NYSE:FRC). U.S. regulators announced JPMorgan Chase (NYSE:JPM) will acquire FRC, and shares in the troubled lender tumbled over 40% in premarket trading, while JPMorgan shares rose. JPMorgan will take over the bank’s assets, including about $173 billion of loans and $30 billion of securities, as well as $92 billion in deposits.

This puts banks back at center stage just as the FOMC prepares to meet. Expect the Fed to give reassurance, but bank failings could be more a symptom of the problem than the problem itself. Three banks have now gone under this year. But the equity markets aren’t reflecting the kind of anxiety one might expect in such an environment.

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Earnings update: Through the end of last week, earnings have been better than expected. The Q1 earnings per share (EPS) decline so far is 1.7%, versus estimates for a 6% drop. Revenue growth is 4% versus preseason estimates for 1.9%. We’re only about halfway through earnings season, but many of the biggest companies have already reported.

Research firm FactSet now expects Q1 earnings to fall 3.7%, versus its March 31 estimate for a 6.7% drop. About 79% of the companies that have reported to date beat analysts’ earnings estimates, and 74% beat on revenue.

It isn’t unusual for actual earnings to outperform expectations, but if this trend continues, it would be a relatively strong improvement from initial estimates. However, research firm CFRA says that while Q1 earnings are coming in better than expected, analysts’ forecasts for Q2 earnings have eroded. CFRA now expects a 4.8% year-over-year decline in Q1 EPS, up from its initial estimate for a 6.5% drop. It then sees a 6.7% decline in Q2. Softening profit margins play a big role.

Also, don’t focus too much on the “beat” rate, says Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research. It’s easy for companies to beat estimates when the bar has been lowered swiftly right before reporting season. “It is indeed positive that the blended growth rate for S&P 500 earnings has improved since the start of the year, but the earnings recession remains intact, profit margins are still under pressure, and forward estimates likely don’t yet reflect the full stress from a potential hit to credit,” he says.

Today doesn’t offer much in the way of earnings highlights, especially after the busy week we just had during which one-third of S&P 500® companies reported. still, this is a busy week, with AAPL on Thursday afternoon at the top of the list. Many of the other companies getting ready to report are a bit less high profile but include household names such as Kraft-Heinz (KHC), Pfizer (NYSE:PFE), Uber (NYSE:UBER), Ford (F), Starbucks (NASDAQ:SBUX), Marriott (MAR), and Anheuser-Busch (BUD). That last one seems apt, considering that by the end of this week it’s likely many investors will be ready for a tall, cold one after the packed calendar they’re working through.

ISM ahead: Soon after today’s open we’ll get the latest look at U.S. manufacturing health in the form of the April Institute for Supply Management (ISM) manufacturing index. It’s been in a tailspin for months, falling to 46.3 in March. That was the lowest reading since May 2020, when the economy was essentially shut down. A 50% figure would be needed to signal expansion, and the index hasn’t been above that since last fall. Analysts expect a slight pop to 46.8 in April, according to Trading Economics. This has been a drag on Gross Domestic Product (GDP).

Growth story: Speaking of GDP, there was a lot of talk after last week’s Q1 GDP report of 1.1% growth that the headline number didn’t represent the full picture. While headline growth was well under analysts’ 2% estimate, the weakness mainly reflected changes to private inventories. On the other side of the coin, consumer spending grew, with spending on goods up 6.5% and on services up 2.3%. Consumer spending makes up about 70% of the economy and may have gotten short shrift from investors when they first glanced at the report. Now that we’re a month into Q2, focus turns to what the current quarter might bring. Expect 1.7% GDP growth in Q2, according to the Atlanta Fed’s GDPNow tool. That’s due for an update today.

A packed earnings calendar and the Fed’s “quiet period” kept interest rate chatter muted last week. That changes in a big way starting tomorrow when the FOMC gathers for its meeting concluding Wednesday. Fed Chairman Jerome Powell’s Wednesday afternoon press conference looms large.

• As of this morning, the probability of a 25-basis-point rate hike stands at 92% according to the CME FedWatch Tool.
• The FedWatch Tool now works in about a 70% chance that the Fed will raise rates in May and then pause at the June meeting. There’s now only a 24% probability of another hike in June, according to the tool.
• After that, the picture’s harder to decipher. The futures market prices in a high likelihood of rates staying on pause through summer before dropping in September. There’s about an 75% probability built into the market that rates will end the year below the current target range of 4.75% to 5%. But the Fed pushes back, forecasting little if any chance of rates falling before 2024 at the earliest. We’ll see Wednesday if anything has changed in Powell’s prognosis.

Happy Monday: Stay up to date with Schwab’s Weekly Market Outlook video every Monday. You’ll get chief global investment strategist Jeffrey Kleintop’s 90-second take on the markets for the week ahead.