Wall Street Subdued Ahead of Expected 50-Basis-Point Fed Rate Hike While Powell Waits in the Wings

(Wednesday Market Open) The market’s collective eyes turn to Washington this afternoon, anticipating fresh insights and data from the Federal Reserve.

Everyone’s in wait-and-see mode ahead of the Fed fireworks, so trading might be thin this morning but possibly volatile later. Major indexes are up about 2% since Friday and trade near recent multi-month highs.

Today’s Federal Open Market Committee (FOMC) decision comes, conveniently enough, immediately after Tuesday’s fresh batch of government data which showed consumer price growth slowed for the second month in a row. Producer prices, however, haven’t eased as much, and sometimes higher producer prices can end up bleeding into what consumers pay down the road.

We’re not out of the woods on inflation, a message you’re likely to hear today from the FOMC and Federal Reserve Chairman Jerome Powell when he speaks during his press conference this afternoon.

On the subject of prices, WTI Crude (/CL) is up this week from recent 2022 lows, lifted by a U.S. supply hiccup and China’s recent reopening. However, today’s reports from China suggest that cases of COVID-19 are climbing rapidly and few are out on the streets. That doesn’t sound like a formula for rising crude demand.

Also overseas, Europe’s October industrial production fell more than expected and the U.K.’s November inflation climbed slightly less than expected. Stocks mostly climbed in Asia and fell in Europe Wednesday.

Morning Rush

The 10-year Treasury yield (TNX) is barely changed at 3.51%.
The U.S. Dollar Index ($DXY) is down slightly at 103.86, near recent five-month lows.
Cboe Volatility Index (VIX) dove yesterday after briefly climbing above 25. Futures trade at 22.6 this morning.
WTI Crude Oil (/CL) is up half a percent at $75.80 per barrel.

Just In

We got another encouraging inflation sign this morning as November import and export prices fell 0.6% and 0.3%, respectively.

Fed Ahead

The FOMC meeting wraps up with a rate decision and economic projections at 2 p.m. ET today. The CME FedWatch Tool projects a 79% chance of a 50-basis-point rate hike and a 21% chance of a 75-basis point rate hike. The chance of a 50-point hike—which would bring the Fed’s target rate to a range of 4.25% to 4.5%—rose after yesterday’s cooler-than-expected Consumer Price Index (CPI) data.

Shortly after the rate announcement, Powell will hold his press conference, and that’s when investors should beware. Powell has been a buzzkill for Wall Street lately, specifically after the last Fed meeting on November 2. On that occasion, stocks posted a slight gain following the Fed’s 75-basis-point rate hike but quickly gave ground and finished down 2.5% as Powell’s hawkish tone slammed the door on optimism.

Yesterday’s November CPI report once again put the market in a positive frame of mind, but you can’t rule out Powell saying something that ruins the holiday mood. With that in mind, anyone planning to trade this afternoon should be prepared for possible volatility.

Quickly glancing again at inflation:

The CPI rose 0.1% versus analysts’ consensus expectations of 0.3%. Core CPI, which strips out volatile food and energy prices, rose 0.2% in November, again below the 0.3% consensus.
We’ve now had two months in a row of cooling monthly data. It’s still a bit early to call this a trend, but some analysts speculated yesterday that the CPI report could result in a lower terminal, or peak, rate projection by the Fed today. That would likely mean fewer or smaller rate increases early next year.

The terminal rate was 4.6% in September, the last time the Fed projected it. The update is likely to be among the first numbers that market participants check this afternoon. Expect the terminal rate to be somewhere between 5% and 5.25%.

Anything below that would likely be seen as supportive for stocks. The main market fear now is the Fed tightening the economy into recession, but a secondary worry is that the Fed might declare victory too soon, allowing inflation to reemerge. Expect Powell to address that today, likely promising tenacity.

Today’s dot-plot will show where each individual FOMC member thinks rates will be at the end of each of the next three years. This will be the first updated dot-plot since September. The key thing to watch is whether the Fed expects rates to begin falling late next year. The path of the dot-plot could be the next volatility-inducing data point.

Numbers to Know

The dot-plot, rate decision, and press conference aren’t the only things wrapped in a bow for investors later today. They also get the Fed’s updated economic projections for 2023 and beyond.

4.4%: That’s the average unemployment rate the Fed projected for 2023 at its September meeting compared with the U.S. Bureau of Labor Statistics’ official reading of 3.7% in November. With recession fears in the air, 4.4% sounds a bit too rosy. Will the Fed raise this number, and, if it does, could that spark more market unease about the economic picture? Also, what will Powell say about the employment picture? Does the Department of Labor’s Household survey, which shows employment down over the last year, have any impact on the Fed’s thinking?

1.2%: Back in September, the Fed projected Gross Domestic Product (GDP) growth at an anemic 1.2% in 2023. A growth rate that low wouldn’t necessarily mean no recession because GDP isn’t the only metric determining that. But it doesn’t leave much room for error. A drop in the Fed’s 2023 GDP estimate from 1.2% would likely cause more recession concerns on Wall Street, perhaps pushing down yields and making analysts go back to their drawing boards to re-assess earnings growth.

7: That’s how many “dots” (on the September dot-plot that saw rates below 4.5% by the end of 2023. If that number climbs in today’s dot-plot, it could support thinking that rates will drop by the end of next year from the expected terminal rate. It’d also likely receive a warm greeting from the market.

Potential Market Movers

The average 30-year fixed rate continued its downward shift last week, according to Freddie Mac. The average slid to 6.33%, down from 6.49% a week earlier.

“With a 6% mortgage rate, housing will become more affordable for many buyers. While the typical family cannot currently afford to buy a median-priced home as the qualifying income exceeds earned income, housing will become affordable again for Americans if rates hover near 6%,” wrote Nadia Evangelou, senior economist for the National Association of Realtors (NAR), on the NAR’s site.

Could this be good news for the homebuilding industry? Lennar’s (LEN) earnings report expected after Wednesday’s market close could provide clues. It’s less about last quarter’s numbers (which were probably negatively affected by the decade-high mortgage rates at the time) and more about what executives expect in the near future. That’s going to be more evident when LEN holds its earnings call Thursday morning.

One potential number to watch in the earnings report is new orders, which fell 12% in the previous quarter. Can LEN get that number to start rising again, particularly with rates still well above 6%?

Reviewing the Market Minutes

Tuesday was a tailor-made case of cooler heads prevailing. The bullish CPI data that came out just before the opening bell yesterday sent markets soaring, with the S&P 500 Index (SPX) rolling up better than 2% gains in the first minutes before scaling back over the next few hours.

It’s a pattern you’re probably familiar with if you follow the market regularly. The lesson is to not let yourself get too carried away by a single data point. With today’s FOMC announcement ahead, it probably makes sense to pare some of those early gains, especially because they came on top of Monday’s rally.

Also, on second glance, it was easy to poke holes in the upbeat CPI report, and that appeared to contribute to the long descent from yesterday morning’s peaks. Food and shelter costs—two expenditures no one can avoid—rose 0.5% and 0.6%, respectively, in November. Both grew less than the month before, but those gains were still on the higher side historically. Apartment rental prices have been falling the last few months, so that’s an important metric to keep watching as more inflation data roll in.

Here’s how the major indexes performed Tuesday:

The Dow Jones Industrial Average® ($DJI) rose 103 points, or 0.3%, to 34,108.
The Nasdaq® ($COMP) gained 1% to 11,256.
The Russell 2000®(RUT) climbed 0.76% to 1,832.
The SPX added 29 points, or 0.73%, to 4,019.

Talking Technicals: We’ve discussed the 200-day moving average (MA) for the SPX a lot lately, and it remained a factor Tuesday. Once again, an early rally above the 200-day MA (now near 4,030) couldn’t hold. Despite all the progress since mid-October, the SPX remains in a long-term technical downtrend, and the 200-day MA is only the first resistance it needs to put behind it to get back into a positive stance (see chart below). Since moving below the 200-day MA back in January, the SPX has spent only a handful of trading days above that level.

CHART OF THE DAY: MATADOR PREVAILS. The bulls rushed the battleline again on Tuesday, but were turned back by the bears as the S&P 500 (SPX--candlesticks) tested the upper end of its downward trending channel. The SPX has now tested resistance twice in the last two weeks and was turned away each time. If the bulls can’t gather more momentum, it’s likely the bears will cause them to retreat, and the downtrend will resume. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

2023 Lift for M&A? Like many industries, life sciences experienced a dramatic plunge in mergers and acquisitions (M&A) activity in 2022, according to trade publication Fierce Biotech. Industrywide, M&A volume in the life sciences industry is down 48% from 2021 while deal valuations plunged 28% this year, the publication noted. Johnson & Johnson’s (JNJ) $19 billion purchase of Abiomed (ABMD) was the biggest acquisition by far before this week’s announcement of Amgen (AMGN) buying Horizon Therapeutics (HZNP) for $27 billion. While M&A suffered in life sciences and beyond, better times may be ahead because small-cap company values are so low relative to where they’ve been. The RUT’s price-earnings (P/E) ratio is down from a year ago, and the value of the index is off 25% from its all-time high in late 2021. That might make large companies look for relative bargains among the small-caps.

Diagnosing Health Care Targets: For life sciences, pharmaceutical firms will be particularly interested in companies working in oncology and immunology, Fierce Biotech reported; developers of vaccines and treatments for the central nervous system and cardiovascular diseases could also be on the list. Still, the trend toward smaller and larger biotech companies teaming up with licensing pacts, rather than actually going through with mergers, could continue into 2023.

Chips Outrun SPX: At its intraday zenith Tuesday, the PHLX Semiconductor Index (SOX) was up 39.4% from its October 13 low and only about 5% below its early August high. It’s more than doubled the SPX’s pace since mid-October. Chip stocks rallied Tuesday after the CPI news, reflecting investor hopes that the inflation dragon might be crawling back toward its cave. Tech stocks in general are growth-oriented and tend to perform best in a roaring economy. Higher rates put the brakes on economic growth and have weighed all year on SOX. The index remains down more than 25% from its January peak and is worth watching if you want a market barometer on where rates might go.

Notable Calendar Items

Dec. 15: November Retail Sales, December Empire State Manufacturing, and November Industrial Production and Capacity Utilization

Dec. 16: Expected earnings from Accenture (ACN)

Dec. 19: No earnings or data of note

Dec. 20: November Housing Starts and Building Permits and expected earnings from General Mills (GIS) and Nike (NKE)

Dec. 21: November Existing Home Sales and expected earnings from Rite Aid (RAD) and Micron (MU)

Dec. 22: Government’s final Q3 GDP estimate and expected earnings from CarMax (KMX)

Dec. 23: November Durable Orders, November Personal Income and Spending, November PCE Prices, November New Home Sales, and Final December University of Michigan Consumer Sentiment

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