With Expectations For Big Fed Rate Cut Tempered, Market Sentiment Is Subdued

The Fed is in focus this week as investors continue to digest bumper jobs data that dampened expectations for an aggressive 50-basis-point rate cut at the central bank’s meeting later this month.

While the market still expects a cut of 25 basis points, the scaled back outlook has dampened sentiment that had been helped earlier by expectations of more-dovish action by monetary policy makers as the trade dispute between the U.S. and China drags on and continues to weigh on expectations for global economic growth.

At the same time, however, it may be that expectations for a 50-basis-point cut may have gotten overblown. So what we may be seeing now is the market settling on one number – 25 basis points – and that might be a more realistic forecast. 

With interest-rate expectations in flux, market participants will likely turn to communication from the Fed this week for clues as to the central bank’s leanings about rate cut action, or lack thereof, at the Fed’s policy setting meeting later this month. 

One place market participants may get some guidance is from the minutes of the Fed’s last meeting, which are scheduled to be released Wednesday afternoon. Also on Wednesday, Fed Chair Jerome Powell begins two days of testimony before Congress. (See more below.)

Looking ahead to Thursday and Friday, the market is scheduled to get key inflation data for June, which likely will factor into the Fed’s decision-making process. On Thursday, the core consumer price index, which strips out volatile food and energy prices, is expected to show a rise of 0.2% according to a Briefing.com consensus. And on Friday, the core producer price index is also expected to show a gain of 0.2% for June. 

Earnings Season Gearing Up

In another place for investors to get some guidance on how the economy is going, earnings season is winding up. As the earnings season isn’t really in full swing, the week is light on corporate earnings reports. But there are a few big-name companies reporting.

Consumer Staples companies PepsiCo Inc PEP and Kraft Heinz Co KHC are scheduled to report this week. Companies in this sector can be considered defensive investments because people generally buy the products they sell regardless of what the economy is doing. So they can outperform other sectors when the economic going gets rough. 

In addition to information on how these companies performed during the quarter, it could also be interesting to see whether their executives have any forward-looking insight about the economy to offer on their conference calls.

Delta Air Lines Inc DAL is also scheduled to report this week. The company can act as a barometer of sorts for the health of the economy. Increased travel among consumers can indicate that they’re feeling good enough about their jobs and prospects to spend the money on travel. And corporations may also spend more on business travel when things are going well or are expected to. (See more on earnings season below.)

Friday in the Rearview

On Friday, the three most active U.S. stock indices pulled back as strong jobs data tempered some expectations about a Federal Reserve rate cut later this month.

The headline payrolls number came in at 224,000, well above the Briefing.com consensus expectation for 160,000 jobs to be created. The new number was a hefty boost from the downwardly revised 72,000 jobs added the previous month.

After the data came out, the futures market indicated increasing expectations for a rate cut of 25 basis points and decreasing forecasts for a cut of 50 basis points. But outside of futures investors, the market as a whole appeared to dial back expectations about an aggressively dovish result from the July meeting. 

That appeared to disappoint market investors who were looking forward to companies being able to borrow money more easily. But at the same time, the data showed that the economy has been stronger than expected, which can boost the fundamentals for companies and drive the market higher over the longer term. 

The data helped spur selling in U.S. government debt (thus pushing yields higher), as investors apparently felt less of a need for relative safety after the strong jobs print. See figure 1 below. Rising Treasury yields helped the Financials sector turn in the best performance of the 11 S&P 500 Index (SPX) sectors.

Shades of Goldilocks: One key part of the jobs report the government releases each month is average hourly earnings data. That number provides a window into the inflationary environment—rising wages mean higher expenses for companies, which may be passed along to consumers in the form of higher-priced goods and services. And when the labor market is as tight as it's been these past couple years, wage pressure could be somewhat expected. So it was interesting that the headline jobs number came in higher than expected but the average hourly earnings for June were up 0.2%, below the 0.3% gain expected in a Briefing.com consensus. Plus, earnings over the 12 months through June were up 3.1%, a bit lower than the 3.2% in the year through May. The strong jobs reading coupled with declining annual inflationary pressure from wages is reminiscent of the Goldilocks scenario of strong economic performance and low inflation.  

Fed Comments Expected: Fed Chair Powell is scheduled to give testimony this week. That could prove particularly interesting to the market given the shifting expectations for a Fed rate cut at its upcoming meeting at the end of July. It could be interesting to see whether Powell reiterates the Fed’s accommodative stance after last week’s bumper jobs report and how the Fed funds futures market might react. While expectations for a 50-basis-point cut have been reduced, the futures market has still fully priced in expectations of a cut of some magnitude, with the majority of participants expecting a cut of 25 basis points. Still, with the strong jobs data, the Fed could end up surprising the market by standing pat on interest rates. If that happens, the stock market could react negatively.

Earnings Ahoy: As earnings season gets underway, it may be a good time to remember that earnings drive the market over the longer term. Though economic data and monetary policy are important, the market is more interested in how these macroeconomic trends might affect future earnings. So while the trade situation with China, numbers that show the health of the economy, and what the Fed decides to do at its meeting later this month are of significance, so too are company results and the comments from executives that accompany them. These on-the-ground insights from executives can be crucial for investors to glean because sometimes they can offer a picture that’s rosier or weaker than what the headline data or central bankers are saying.

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.

Image sourced from Pixabay