Markets Firmer Overnight Amid Optimism Debt Ceiling Deal May Happen

(Monday market open) Heightened hopes that the U.S. will avoid a debt ceiling debacle appear to have put a floor under the market, with stocks poised to start the week on a firmer note as investors await key earnings reports from several major retailers.

Stock index futures based on the S&P 500® and Dow Jones Industrials Average rose overnight after the Wall Street Journal reported Saturday that the Biden administration and congressional Republicans are making progress in negotiations over federal spending and raising the debt limit. Treasury Secretary Janet Yellen said she’s “hopeful” the talks could result in an agreement, the newspaper reported.

A debt ceiling agreement would remove some uncertainty as the market shifts into the tail end of earnings season, with Federal Reserve policy and recession prospects still front-and-center topics. A larger-than-expected drop in a New York state manufacturing index fueled recession concerns, but don’t expect the Fed to make any significant moves away from its inflation battle, based on fresh comments from the central bank’s Atlanta leader.

• The 10 Year Treasury Yield was up about 3 basis points at 3.489%

• The U.S. Dollar Index ($DXY) fell slightly to 102.475

• The Cboe Volatility Index® (VIX) rose 0.39 to 17.42

• WTI Crude Oil (/CL) was up 48 cents at $70.52.

Treasury bills remain volatile as the debt ceiling issue remains unresolved. ”Treasury bills maturing before that June 1 “X” date are trading at premium, with bills maturing later this month offering yields below 4% as investors pay up for more certainty that they’ll be repaid on time,” notes Collin Martin, director, fixed income strategy, at the Schwab Center for Financial Research. “Meanwhile, bills maturing on June 1 and in the days that follow offer higher yields as investors demand more compensation for the risk that they aren’t repaid on the scheduled maturity date.”

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Atlanta Federal Reserve President Raphael Bostic doesn’t expect any interest rate cuts at least through 2023, even if the economy slips into recession. “For me, inflation is job No. 1. We’ve got to get back to our target,” Bostic told CNBC’s Steve Liesman during an interview this morning. “If there’s going to be some cost to that, we’ve got to be willing to do that.” Bostic’s remarks appear to punch holes in ideas the Fed could lower rates as soon as July, based on the CME FedWatch Tool.

The Empire State Manufacturing Index, a measure of business conditions in New York state, dropped to -31.8 from 10.8 previously, well below expectations for a decline to just -3.7.

Cash registers ring: Retail companies crowd the earnings calendar this week, kicking off tomorrow morning with Home Depot (NYSE:HD). That’s expected to be followed by Target (NYSE:TGT) and Walmart (NYSE:WMT) on Wednesday and Thursday mornings, respectively. Foot Locker (NYSE:FL) wraps things up Friday, with more major retailers ahead next week.

Most big-box stores wrestled with rising prices in late 2022. Many shared conservative guidance early this year, and executives expressed concerns about consumer sentiment in these high-rate, high inflation times.

A critical element to watch is what the companies say about discretionary spending, versus staples. Are people still tightly clutching the Charmin, so to speak, or are they making more “fun” purchases? That could tell us a lot about whether recession looms, as consumer spending makes up about 70% of the economy. A recent rise in initial jobless claims suggests consumers may remain reticent, but we’ll see what the big boxes have to say.

Digging the foundation: With HD up first, it’s worth noting that last week, Baird lowered the firm’s price target on HD. Channel checks point to another lackluster start for outdoor seasonal categories, the analyst tells investors in a research note. However, Baird believes seasonal sales in May “are off to a hot start.”

Last time out, HD projected flat sales and comparable sales growth for fiscal 2023, and also forecast a diluted EPS decline in the mid-single digits. Check closely when HD reports to see if the company makes any changes to that relatively gloomy outlook.

Exceeding expectations: As of Friday, 92% of the companies in the S&P 500® have reported earnings for Q1. Of these companies, 78% have reported actual EPS above the mean EPS estimate, which is above the 10-year average of 73%, according to research firm FactSet. It’s also the highest percentage of S&P 500 companies reporting a positive EPS surprise since Q3 2021.

The probability of a June rate pause stands at 83%, according to the CME FedWatch Tool.

Friday’s preliminary May University of Michigan Consumer Sentiment report sent mixed signals on inflation. Year-ahead inflation expectations pulled back to 4.5% after rising to 4.6% in April. However, the five-year outlook increased to 3.2%, the highest since 2011, compared to 3% last month. The Fed has made it clear how important it is to keep inflation expectations “anchored,” and last year when the survey showed a big jump in five-year expectations the Fed quickly increased the pace of rate hikes.

That said, we’re in a different place now. Inflation has receded quite a bit since then, and data hint at a slowing economy. This was one report and the Fed reviews a vast swath of data. The one-year expectations decrease was also encouraging.

Perhaps with that in mind, the market still expects rate cuts this year.The fed funds market suggests a rate cut as soon as the fall, with three cuts being priced in by the end of the year. However, Fed officials keep pushing back with pledges to hike rates again if necessary to tame inflation. At this point, with the fed funds rate above the annual inflation rate, the Fed arguably might start feeling a bit less pressure to push rates higher. That doesn’t mean it will slice rates, despite market hopes, especially with unemployment so low.

Sales call: Along with HD earnings, tomorrow brings April Retail Sales data before the opening bell. Retail sales were on the light side in March, but that partly reflected low energy prices that kept gasoline sales down (the report isn’t adjusted for inflation). Trading Economics says the updated consensus for April is a 0.6% rise sequentially in overall retail sales and a 0.3% bump in retail sales excluding automobiles.

If numbers are softer than expected, it could intensify ideas that a recession is brewing, Consumer spending forms about 70% of the U.S. economy, so if people sense their wallets getting lighter, that can show up in Retail Sales data.

And Friday’s Consumer Sentiment survey didn’t exactly inspire confidence, falling sharply to a six-month low of 57.7 from 63.5 in April, well below forecasts of 63. “Consumers’ worries about the economy escalated in May alongside the proliferation of negative news about the economy, including the debt crisis standoff,” said Surveys of Consumers Director Joanne Hsu. However, that was May data, not April, so it may not have an impact on the April sales figure.