Rally Flags as Yields Rise After Projections of More Hikes

(Thursday market open) The relentless rally took a breather this morning following the Federal Reserve’s “hawkish pause.” Treasury yields rose, putting pressure on the red-hot info tech sector in premarket trading.

The main takeaway from Wednesday’s Federal Open Market Committee (FOMC) projections is to expect more rate hikes. And that’s hikes—plural.

After pausing rate increases yesterday for the first time since early 2022, the vast majority of FOMC policymakers predicted two or more hikes by the end of the year, according to the Federal Reserve’s latest dot-plot of future rate estimates. The FOMC’s statement “strongly implies that more hikes should be expected,” say analysts from the Schwab Center for Financial Research.

Regional banks and retail were among the weakest sectors on Wednesday as major indexes initially lost ground and then rebounded slightly after the Fed meeting to post a mixed close. The KBW Regional Banking Index (KRX) tumbled from a 14-month high earlier in the day, ending down nearly 3%. Small-caps stocks also took a hit, as the Russell 2000 Index (RUT) fell 1.2%.

• The 10-year Treasury note yield (TNX) edged up to 3.83%, near the top of its recent range.
• The U.S. Dollar Index ($DXY) rose to 103.21 after the Fed indicated more rate hikes ahead.
• The Cboe Volatility Index® (VIX) futures rose slightly to 14.1.
• WTI Crude Oil (/CL) was slightly higher at $69.13 per barrel.

The U.S. Dollar Index ($DXY) rebounded sharply Wednesday from a four-week low, boosted by indications rates could stay higher for longer. Crude oil (/CL) came under pressure from the higher dollar and growing U.S. crude stockpiles but rebounded this morning.

The Fed may have paused on rate hikes for now, but the European Central Bank (ECB) didn’t follow suit. The ECB raised rates another quarter-point to 3.5%, as analysts had expected, in what Bloomberg reports might be the penultimate hike in a long cycle of increases. Inflation across Europe has been coming down, but the market builds in high chances of one more rate increase in July. Investors now await comments from ECB President Christine Lagarde. The Bank of Japan’s (BoJ) policy decision is due Friday. Soft economic growth across Europe helped stall a stock market rally that began there earlier this year.

Get The News You Want

Read market moving news with a personalized feed of stocks you care about.

Get The App

Back home, U.S. May Retail Sales rose 0.3%—a little more than market expectations but down from 0.4% in April. They rose just 0.1% without automobiles included. Initial jobless claims for the most recent week remained elevated at 262,000, equal to the previous week’s revised level and well above historic lows below 200,000 seen earlier this year. These numbers likely won’t look too worrisome from an inflation/interest rate perspective. In fact, the rising claims could make the Fed’s job easier if they remain at these levels or higher, potentially signaling less wage inflation.

Judging from the FOMC’s latest projections, it’s almost a given that rates will continue to rise later this year, barring some sort of economic upheaval. This pause might not be too refreshing, so to speak.

On the other hand, Fed Chairman Jerome Powell emphasized more than once in his remarks yesterday that the Fed’s July gathering is “live,” meaning another rate hike at that time isn’t a foregone conclusion. That’s no great surprise—he and his colleagues likely don’t want to corner themselves.

Nevertheless, the market now bakes in a 75% probability that the FOMC will raise rates 25 basis points to between 5.25% and 5.5% at the July 25–26 meeting, according to the CME FedWatch Tool. There’s a 52% probability that rates will remain in that range through the rest of the year, and the market only works in slight chances (10%) of the FOMC raising rates twice more this year as the dot-plot projects.

• Inflation remains too high, labor market gains are robust, and economic activity continues to expand, the Fed’s statement said. It projects much more robust Gross Domestic Product (GDP) growth for 2023 (1% versus the previous 0.4% projection) despite the higher rate environment. It expects unemployment to top at 4.1% this year, versus the old 4.5% forecast.
• Essentially, the Fed thinks it can fight inflation with rate hikes and not cause too much stress on the economy. Market participants often call this a “soft landing,” albeit with below-trend economic growth and perhaps a slowing labor market. “There is a path to getting inflation back down to 2% without having to see the kind of sharp downturn and massive unemployment seen in past instances,” Powell said, referring to the Fed’s 2% inflation target.
• Even with the projected slowdown, the FOMC sees core Personal Consumption Expenditures (PCE) prices rising a hefty 3.9% this year, up from the previous forecast of 3.6%. It kept its 2024 core PCE prices forecast unchanged at 2.6%. “Looking at core PCE inflation overall over the last six months, we’re not seeing a lot of progress,” Powell said. The FOMC’s projections don’t show core PCE returning to near 2% until 2025.
• Keep in mind that the Fed’s words and projections sometimes can shape financial conditions more than its actions. Pausing allows the Fed to assess what it’s already done and the potential fallout, even while signaling a more hawkish outlook. The market, based on futures trading, seems to think the Fed is jawboning with those hawkish projections, but doesn’t necessarily believe they’ll come true.

Stocks reached 14-month highs this week, but that doesn’t necessarily reflect the world where many everyday Americans try to make ends meet. Recent consumer surveys and last quarter’s retailer earnings show many people struggling despite low unemployment and rising wages. That could play into tomorrow’s preliminary University of Michigan June Consumer Sentiment report.

The final May sentiment figure of 59.2 was down from April’s 63.5 and barely up from a year earlier. Tomorrow’s sentiment data, due shortly after the open, isn’t expected to reveal huge improvement, according to analysts’ consensus of 60.2 from Briefing.com.

One standout from the report could be year-ahead inflation expectations, which slipped to 4.2% in May. The May Consumer Price Index (CPI) showed declining food and energy prices, so it’ll be interesting to see if that played into expectations. Another element to track is the year-ahead economic outlook. It plunged 17% in May, reflecting recession concerns.

Software company Adobe (NASDAQ:ADBE) is set to report earnings after today’s close, and the focus is likely to be on developments related to artificial intelligence (AI) and the company’s pending $20 billion acquisition of collaborative design software company Figma, Barron’s reports. Shares of Adobe have been on a roll lately, boosted by optimism around AI.