Bank of Japan Shakes Up Global Markets With Surprise Bond Move

(Tuesday Market Open) Bonds grabbed the spotlight Tuesday after Japan surprised global market participants with a hawkish move on yields. Still, after the smoke clears, U.S. housing data might deserve more attention. 

The Bank of Japan (BOJ) didn’t raise rates, but it did change policy to allow its benchmark bond yield to trade as high as 0.5 from the previous 0.25%. That sent bonds reeling all around the world, putting pressure on stocks, especially Asian markets. U.S. stock index futures initially plunged overnight on the news but regained most of those losses ahead of the opening bell. The dollar came under pressure, too as the yen galloped to gains.

BOJ said its decision wasn’t an inflation-fighting move, just a tweak to ensure smoother functioning of the bond market. Japan still has nearly zero interest rates because inflation hasn’t been a major problem there.

To put things in context, it would have been a lot more serious if the BOJ had actually raised rates, but it didn’t. Everyone’s hyper-focused on central banks and today, it’s all about the BOJ.

Even before the BOJ’s move, rates here in the U.S. were on the upswing, breaking a recent pattern. The U.S. 10-year Treasury yield (TNX), which rose to a nearly two-week high on Monday of nearly 3.58%, added several more basis points this morning to 3.66%. That’s up 26 basis points from the December low.

Higher yields earlier this year weighed on the stock market, but the recent decline from levels above 4% appeared to provide a tailwind for Wall Street.

Closer to home, November’s U.S. Housing Starts and Building Permits both fell from the previous month to seasonally adjusted levels of 1.427 million and 1.342 million, respectively. The starts number was slightly above Wall Street’s consensus, but the permits number—important because it hints at future demand—was down dramatically from the expected 1.48 million. In short, there are more signs that housing might be cooling off.

It certainly looks like the Federal Reserve’s tighter rates are starting to slow the economy. That’s showing up in the high-growth, interest rate-sensitive sectors, which is one reason small cap stocks are down. The Fed doesn’t appear likely to pivot. Its resolve continues strong and Wall Street may be catching on that the central bank is willing to weather an economic slowdown if it has to.

Major indexes remained under pressure as the opening bell approached and have suffered four-straight losing sessions. The S&P 500® index (SPX) is down more than 6% so far in December amid recession fears.

Morning Rush

• The 10-year Treasury yield (TNX) rose sharply, up 7 basis points to 3.66%.
• The U.S. Dollar Index ($DXY) fell 0.5% to 104.15.
• Cboe Volatility Index® (VIX) futures are nearly unchanged at 22.56.
• WTI Crude Oil (/CL) climbed 1.3% to $76.19.

Potential Market Movers

Belying common wisdom about this being a quiet time of year, two heavy hitters—Nike NKE and FedEx FDX—are expected to share their earnings today after the close.

• FDX is often a handy consumer sentiment barometer, especially this time of year when so many people send holiday packages. Back in September, however, FDX warned of tough times, and the stock plunged. Shares are down about 15% from the last time the company reported earnings. And with many analysts warning of a possible recession, it’s easy to see why there’s pessimism for companies like FDX and competitor UPS (UPS) that rely on consumer demand. There’s also concern that rising costs could weigh on FDX margins, Forbes reported.
• NKE shares went on a tear from early October to mid-December, rising 36% amid hopes for a reopening of the Chinese economy and Wall Street reports of strong brand performance. Many analysts remain upbeat on the stock despite the dive it took over the last week. One question is whether the company made progress chewing through its inventory issues, which weighed on shares earlier this year.

China’s outlook remains an uncertain for NKE. That country is an important part of NKE’s business, and analysts expect somewhat stronger economic growth for China in 2023 after this year’s disappointing 3% pace. However, that depends how quickly Beijing can navigate through the recent rise in COVID-19 cases, which appear to be keeping many people at home for the moment.

Just a reminder that investors will have to stick around until the end of the week for the most significant economic data: Thursday’s final government reading on Q3 Gross Domestic Product, followed early Friday by December Consumer Sentiment, November New Home Sales, November Durable Orders, and November Personal Consumption Expenditure (PCE) prices.

The PCE data might be the biggest one to watch. Consensus on Wall Street now is for a 0.3% rise. This is the inflation indicator the Fed most closely follows.

Shortly after Wednesday morning’s open, we’ll get a look at November Existing Home Sales. The Wall Street consensus, according to Briefing.com, is 4.2 million on a seasonally adjusted basis, down from 4.43 million in October.

One metric to watch is median home prices, which climbed 6.6% in October and were up for the 128th month in a row—a record. Any sign of moderation in prices might receive applause from Fed watchers because rising home values exacerbate the “wealth effect” that can lead to heavier consumer spending and potential inflation.

Reviewing the Market Minutes

Recession lights keep flashing on Wall Street as the major indexes fell Monday for the fourth-straight day. How do we know recession fears drove at least some of the selling? Check the sector performance.

Sectors that tend to do best in a growing economy like info tech, communication services, and consumer discretionary were bottom dwellers once again on Monday, and staples, health care, and utilities were part of the top-five performers. Some analysts blamed tax-loss harvesting for some of the recent downturn in stocks.

The SPX Technology Select Sector index (IXT) is down nearly 8% this month alone, bruised by an 11% plunge in Apple (NASDAQ: AAPL) shares—its largest component. Concerns about the company’s production in China and the possibility of recession continue to dog that mega-cap, which is scraping against its 2022 lows.

Interestingly, energy is getting a bid the last few days, possibly from China loosening its COVID-19 restrictions.

Here’s how the major indexes performed Monday:

• The Dow Jones Industrial Average® ($DJI) fell 162 points, or 0.49%, to 32,757.
• The Nasdaq® ($COMP) dropped 1.49% to 10,546.
• The Russell 2000®(RUT) stepped back 1.34% to 1,739.
• The SPX dropped 34 points, or 0.9%, to 3,817.

Talking Technicals: We discussed Fibonacci levels yesterday, and they remain relevant in tracking the SPX from a technical standpoint. The SPX plunged quickly yesterday below support at 3,850, 3,845, and 3,840. The next support test was 3,819, which represents the 38.2% Fibonacci retracement level from the March 2020 low to the January 2022 peak. That succumbed quickly as well to Monday’s selling pressure, and the SPX eventually declined all the way to 3,800 with just an hour left in the session.

The drop to 3,800 appeared to wake up some bulls, and the SPX clawed its way back to 3,817 by the end of the day, within a whisker of the Fibonacci level. It was the second session in a row with some signs of life in the last hour as well as the second in a row that saw the SPX pivot around that level. Does any of the late enthusiasm spill into trading today? Questionable. The path of least resistance still seems downward, but after four consecutive lower sessions, perhaps remaining bulls can rally around the 3,819 flag.

CHART OF THE DAY: FEELING BULLISH? If you think the market is waving a red cape, here’s a couple of barometers that may get you to slow down. Both the Dow Jones Transportation Average (DJT—candlesticks) and the Nasdaq Biotech Index (NBI—purple line) can be early indicators of better times ahead, but they’ve been falling this month. Don’t take your eyes off these matadors as the new year begins. Data sources: S&P Dow Jones Indices, Nasdaq. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

Family Squabble: If you think of the Fed as the ultimate umpire calling the balls and strikes for Wall Street, think again. There’s a fairly well-matched fight going on between market participants and the Fed about whether the central bank will keep rates elevated through all of 2023. The Fed’s dot-plot from last week’s Federal Open Market Committee (FOMC) meeting showed interest rates peaking next year between 5% and 5.25% and pretty much staying there the whole year. The dot-plot showed no signs of rates easing until 2024 at the earliest. Don’t fight the Fed? Futures traders don’t seem convinced. They’re pricing in better than 95% odds of a cut from the terminal, or peak, rate by December 2023. Rates a year from now, according to the CME FedWatch Tool, will be below 5%. Of course, there’s no certain way to find out who made the right call until we get there.

More Firepower: In an otherwise dreadful year for stocks, you’d have to look long and hard to find a subsector with 35% gains. However, that’s exactly where the defense subsector stands with two weeks left in 2022. Defense basically consists of a handful of monster stocks—including Northrop Grumman (NOC) and Lockheed Martin (LMT)—which control the bulk of sales to the Pentagon. The industry’s run of good news is expected to roll along this week as Congress prepares to approve an $858 billion 2023 defense budget, according to The New York Times. Passage would mean military spending rising 4.3% over the last two years after averaging less than 1% per year in real dollars between 2015 and 2021. Some of the new military procurements will be to support U.S. efforts to aid Ukraine, but supply problems could continue to be a challenge for the industry.

Mark-to-Market to Missiles? A surprising discrepancy this year between job availability and job seekers is one factor driving wage growth and inflation, according to the Fed, and the defense subsector is a good example. Raytheon (RTX), for instance, hired 27,000 new employees so far this year but continues to run into bottlenecks in terms of labor shortages. Supply chain problems and labor shortages are also a challenge for LMT, which stated on its site, “Aerospace and defense is facing a shortage of skilled labor to perform successfully in today’s advanced manufacturing environment.” LMT is partnering with academia and state and federal governments to develop curriculum and support scholarships for veterans and unskilled and displaced workers.

This underscores a problem some economists have pointed out about how difficult it is to match unemployed workers to jobs. The kind of skilled positions available in the defense subsector, for instance, may not be accessible to a person laid off from an investment bank (an industry seeing recent job cuts). There’s a mix-and-match problem that defies easy solution, and it could mean companies are scrambling to pay up—or train up—for the kind of talent they need. That’s the kind of problem the Fed wrestles with as it tries to prevent runaway wage growth from pushing inflation into even hotter territory.

Notable Calendar Items

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

Dec. 26: Markets closed for official Christmas Day holiday. Enjoy if you celebrate!

Dec. 27: December Consumer Confidence

Dec. 28: November Pending Home Sales

Dec. 29: Weekly Initial Unemployment Claims

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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