Rate Reverberations: Market Coming To Terms With Chances Of Neutral Fed
TD Ameritrade | May 02, 2019 11:32AM ET
(Thursday Market Open) The Fed threw one right down the middle late Wednesday, declining to hike or cut interest rates and hinting that it might not make any additional rate moves for a while.
Stocks responded like a child who just had the cookie jar taken away. The jar in this case appeared to be hopes that Fed Chairman Jerome Powell would dangle the chance of a near-term interest rate cut. However, like a strict parent denying that cookie, Powell stuck to his guns. The S&P 500 Index (SPX), which had been up about 0.2% right after the Fed decision, slid 0.75% by the end of the session.
Stocks took on a more neutral tone in pre-market trading early Thursday as investors geared up for Friday’s payrolls report. Earnings continue to roll in and might take focus off the Fed, but it’s possible that Powell’s words yesterday could continue to reverberate for a while.
h3 Powell Dashes Rate Cut Hopes/h3Asked point-blank at his press conference Wednesday if the Fed was considering a rate cut, Powell replied, “We don’t see a strong case for moving in either direction,” adding that the Fed is comfortable with its current target range of between 2.25% and 2.5%. The Fed said in its statement that it plans to be “patient” about future moves.
Stocks had rallied to record highs late last month, but it’s unclear how much of that was based on rate easing hopes. Better-than-expected earnings and optimism for a deal with China also probably played a big role.
Few investors actually seemed to expect a cut at Wednesday’s meeting, judging from Fed futures, but the CME FedWatch tool had predicted about a 20% chance of a cut in June. That sank to about 7% by late Wednesday after Powell’s words. Stocks sank along with bullish hopes for more Fed stimulus.
Chances are still around 50% for a cut by the end of the year, however, and the futures market doesn’t see any chance of rates going up in 2019. However, the 50% odds of a 2019 rate cut are way down from around 75% earlier this week.
In a sense, the Fed’s reluctance to ease borrowing costs could be viewed as bullish, even though that wasn’t how the market saw it on Wednesday. If the Fed feels rates can stay at current levels, it likely signals that the central bank believes the economy can continue growing without more stimulus. It’s hard to see that as a negative if you’re looking for signs of U.S. economic strength.
Also, for those who might be worried about current “high” rates potentially clipping growth, remember, the target range remains low on a historic basis.
The other thing that might have bothered some investors was Powell’s description of current low inflation as “transitory,” and his belief that it will eventually rebound toward the Fed’s targeted 2%. If that’s how the Fed sees things, it arguably makes a rate cut even less likely anytime soon. After all, lower rates have a tendency at times to generate rising prices. With that in mind, the Fed might be hesitant to ease policy. The argument could be made though, that one way to get inflation back to the Fed’s target would be to drop rates. We’ll have to wait and see where the Fed eventually lands.
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As Powell said, inflation can rise and fall over the course of a given year, and it’s probably best to take a long-term view. At a core rate of 1.6% now, inflation might be getting beaten down by weak demand overseas and by slower business investment here at home. Those are two trends to consider watching as investors try to figure out what the Fed might do next.
h3 Data Disappoint/h3Another thing to consider keeping an eye on is data over the next week or two, including Friday’s April payrolls report (see more below). The latest data this week seemed a little listless compared with last Friday’s surprisingly strong 3.2% gross domestic product (GDP) growth for Q1. Both March construction spending and the April ISM Manufacturing numbers came in below analysts’ expectations. Mortgage applications fell pretty sharply last week, and the personal consumption expenditure (PCE) price index for March also failed to shine. Chicago PMI for April looked particularly flat at 52.6, the lowest level since January 2017.
Before Powell splashed a little cold water on the parade, stocks had been flat to higher Wednesday. A report right around the time the Fed meeting ended that the U.S. and China may have a trade deal to announce as soon as next Friday helped give the market a lift. Also, Apple (NASDAQ:AAPL) shares rose almost 5% on better-than-expected earnings and guidance after reporting late Tuesday.
Thursday brought another slew of earnings data. Qualcomm (NASDAQ:QCOM), DowDupont (NYSE:DWDP), YETI (NYSE:YETI), Dow (NYSE:DOW) and Under Armour (NYSE:UAA) are among companies in the spotlight. News looked good from UAA, while QCOM beat third-party consensus views on earnings and revenue but gave guidance that came in under the Street’s expectations.
The data calendar later today includes March factory orders, but it’s likely most people will be focused on tomorrow’s payrolls report (see more below). There’s been a little uptick in volatility the last couple days as the market faced earnings from Apple, the Fed meeting, and jobs data. The VIX—sometimes thought of as the market’s “fear indicator”—rose above 14 early Thursday, up from below 13 earlier this week. That could signal a bit more choppiness ahead.
For the S&P 500 Index (SPX), Wednesday’s showing was its worst for any day since March 22, but it did remain well above 2900 and not far off of recent all-time highs. From the 30,000-foot view, a day like Wednesday’s might feel unpleasant, but can sometimes be healthy for a market that’s been flying so high for so long. Nearly every sector finished lower, with Energy really taking it on the chin thanks in part to rising U.S. crude stockpiles (see below).
The 10-year Treasury yield moved slightly higher early Thursday to about 2.51%, from under 2.5% at times yesterday. Powell’s comment about low inflation being “transient” might put some pressure on bonds, analysts said.
Figure 1: Big Reversal: This 9-month chart, going back to early August, shows how 10-year yields (candlestick) have reversed their upward path even as the S&P 500 Index (purple line) bottomed out in December and rose sharply as the Fed stepped back from rate hikes. Data Sources: Cboe, S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Payroll is Up Next: April payrolls loom Friday morning, the next highlight in a week that’s been full of them. Job growth is expected to be around 200,000, according to a Briefing.com consensus, with unemployment holding steady at 3.8% and hourly pay up 0.3% from the month before. That would be a bigger rise in wages than the 0.1% monthly increase seen in March. Investors might want to keep a close eye on construction and manufacturing jobs to see if they popped back in April after some weak months.
It might also be interesting to see if the government makes any revisions to the February and March data Friday. In March, 196,000 jobs were created, about 20,000 above expectations, and way above the growth of 33,000 in February. It’s still possible that the dichotomy between those two months might have something to do with the government shutdown in January, so we’ll see.
Test Flight: How can a company help address customer fears after its product is involved in two fatal accidents? Boeing (BA) faces that question as it works to get its 737 MAX planes back into service. One idea the company appears to be thinking about is a confidence-building strategy it used a few years ago after its 787 airliner was grounded due to battery problems. That is, having its own executives take some of the first flights. In 2013, then-Boeing (NYSE:BA) CEO Jim McNerney was one of 219 passengers on United Airlines (NASDAQ:UAL) Flight 1 of the 787 from Houston to Chicago, CNN reported at the time. He was joined by executives from the airline.
At the recent BA investor meeting, CEO Dennis Muilenburg said he’s already ridden on two 737 MAX test flights equipped with updated software, CNN reported. He also said he and other BA executives will be on some of the first flights once the plane is back in commercial service. “It will include me and many others,” he said. “This is a really important part in showing our confidence in our product.”
Crude Calculations: Either U.S. crude producers are working overtime the last couple of weeks, or motorists are reacting to high gas prices by driving less. There may be other explanations, too, but whatever the case, crude stockpiles are up pretty dramatically since mid-April. They rose nearly 10 million barrels last week, the Energy Information Administration (EIA) reported Wednesday, following a 5.5-million-barrel build the week before. One possibility is that producers might building up supplies ahead of the summer “driving season,” which traditionally starts around Memorial Day. Total crude inventories are at 470 million barrels, about in line with the five-year average. If crude supplies do keep building into summer, that might be a sign of demand issues, which can be a sign of economic softness. So it might be worth keeping an eye on these weekly reports.
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