First Session After Rate Hike Seems To Have Investors Mulling Fed Comments

With the year’s third Fed rate hike out of the way, investors could still have plenty to chew on as they digest commentary from monetary policy makers about the economy and potential future trajectory of interest rates.

Even as they process the latest Fed speak, investors also appear to be looking toward the possibility of a fourth rate hike this year. While yesterday’s hike was widely expected, the probability for a fourth hike is slightly less, although still substantial at nearly 83 percent, according to Fed funds futures.

At the same time, trade concerns haven’t gone away heading into the last quarter of the year. And oil prices are on the rise. If you’ll recall, many company executives in Q2 earnings season mentioned worries over higher energy prices.

In economic news this morning, the government’s third estimate for Q2 GDP came in at a seasonally and inflation-adjusted annual rate of 4.2 percent. That was slightly less than a consensus estimate of 4.3 percent provided by Briefing.com but was the same as the government’s prior estimate. 

Stocks Seesaw After Fed

After being in the green most of the day, the three main U.S. indices finished lower following the Fed’s comments on monetary policy after it announced its third interest rate hike this year.

The Fed removed “accommodative” from its press release, and stocks initially increased their gains as investors may have believed that the Fed thought it had raised interest rates enough, or nearly so, to no longer consider its policy accommodative. 

But after the announcement, Chairman Jerome Powell told reporters that removing the word doesn’t signal a change to the path the Fed thinks likely for interest rates.

That argues for the Fed potentially continuing its gradual interest rates increases. Indeed, in its statement, the Fed said it “expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.” 

Expectations for gradual increases to the Fed funds rate come as the U.S. economy is performing well and inflation doesn’t appear problematic. So theFed’s removal of “accommodative” could signal that it believes the economy can forge ahead on its own with less help from ultra-low interest rates.

With Wednesday’s move, the target range for the federal funds rate now sits between 2 and 2.25 percent. That’s the highest it’s been since the Great Recession a decade ago, but just barely into the 2 to 5 percent range where the Fed has historically kept rates. 

10-year Treasury Yield Pulls Back

Even though the Fed pushed its short term rate higher, the yield on the 10-year Treasury pulled back after Powell said the Fed doesn’t see inflation surprising to the upside, according to media reports. It seems like the Fed is saying it continues to see room for gradual rate increases and that the need for more drastic measures that would push up rates faster may not be necessary.

The falling 10-year Treasury yield could have helped push financial stocks lower (see Fig. 1 below). That sector was the biggest loser among the S&P 500 sectors, falling 1.27 percent. Banks often do less well when longer term rates decline because that means they can’t charge as much interest on loans relative to what they earn on deposits.

However, the 10-year yield remained above the psychologically important 3 percent mark, and the Fed seems to be in a rate hiking mode. That may be what investors were focusing on when they sold off real estate and utilities stocks yesterday. Those S&P sectors slumped 1.15 and 1.04 percent, respectively.

Those stocks tend to falter as interest rates rise. They generally have a track record of strong dividend payments and solid growth, making them competitive when bond rates are low and investors are seeking yield. As yields rise, these stocks, which are considered riskier than bonds, tend to become less sought after.

Figure 1: Banks Lead Way Down: A Fed rate hike wasn’t enough to help financial stocks, and a weak performance by the financial sector late Wednesday seemed to help push the Dow Jones Industrial Average (purple line) to a lower close after an initial rally after the Fed decision. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Rates, the Dollar, and Multinationals

A factor that could be playing into the rate picture is how the greenback might fare. Historically, higher U.S. interest rates tend to be dollar friendly, and the dollar has been on mostly an upward trajectory this year. While a stronger dollar can help consumers by making imports cheaper and trips abroad more of a bargain, it also can eat into company profits, especially for companies that sell a lot of product overseas. For instance, Nike Inc. NKE, which reported results Tuesday and sees 60 percent of sales come from outside the U.S., is an example of a company that could potentially face challenges from a higher dollar. Other companies that come to mind include Caterpillar Inc. CAT, Deere & CO. DE, General Electric Company GE, and IBM IBM.

Historical Perspective

Rising interest rates can trigger worries among investors that the Fed might get too hawkish and needlessly put a damper on equities. But even if the Fed hikes rates once more this year and three times next year, investment research firm CFRA doesn’t seem worried based on the difference between the Fed funds rate and the consumer price index. Action Economics is forecasting a year-on-year gain in the headline consumer price index (CPI) of between 2.2 and 2.7 percent through the end of 2019 and expects 25-basis point Fed rate hikes in December and three times next year, taking the Fed funds rate to just below 3 percent by the end of 2019, CFRA said. That would leave the spread between the Fed funds rate and CPI below the narrowest difference of 0.83 percentage points recorded before the start of any bear market for more than 60 years, CFRA said. On average, the fed funds rate was 2.5 percentage points higher than the annual change in headline CPI just before all bear markets since 1955, the firm said. “CFRA does not think the rise in short-term rates will end up triggering a near-term slump in stocks,” the firm said.

Rising Home Prices

Sales of new homes in August rebounded, but home prices continued to rise, the government said Wednesday. A new report showed that even as new home sales in August rose 3.5 percent to a seasonally adjusted 629,000 units from a downwardly revised 608,000 in July, the average sales price was up 5.2 percent year-over year. While Wednesday’s data marked the first gain in new home sales in two months, the figure also came in a bit below expectations for 630,000 units forecast by a consensus of economists provided by Briefing.com. As for July’s downward revision, it was lower than the previous reading of 627,000 units. The inventory of new homes for sale also rose in August from the year-ago period, according to the report. The question is whether higher prices may be putting a cap on demand. Prices have been on the rise as input costs such as lumber and steel increase, and at the same time mortgage rates have increased. “The key takeaway from the report is that it reflects the affordability constraints that are increasing on the back of high prices and rising mortgage rates,” Briefing.com said.Good Trading, 

Information from TDA is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade.