Don't Celebrate Yet: Lower Wholesale Inflation Data Mainly Reflected Drop In Energy Prices

(Thursday market open) More signs emerged early Thursday of cooler inflation, as the March Producer Price Index (PPI) fell 0.5%. It was the first monthly slide in PPI since December, and while it reflected a big drop in volatile energy prices, other areas also showed progress.

Core PPI, which strips out food and energy, fell 0.1% in March, down from a flat reading in February. Overall headline PPI was down 0.1% in February.

In another sign that the economy might be responding to higher rates, initial unemployment claims soared to 239,000 last week, marking the second week in a row coming in higher than analysts had expected.

Stock index futures were relatively flat after the reports, both of which provide more evidence that the primary risk facing markets may no longer be inflation, but instead the trajectory of the economy.

Prior to PPI, stock index futures had a quiet night following yesterday’s lower settlements. Volatility remains light, and Treasury yields appear relatively rangebound. Recession worries flared after yesterday’s Federal Reserve minutes, but earnings season and company forecasts could provide more insight into where the economy might be headed.

Overseas, the U.K. economy flatlined in February with zero growth in Gross Domestic Product (GDP). That followed 0.4% growth in January and was below analysts’ consensus for 0.1% growth.

Morning rush

• The 10-year Treasury note yield (TNX) fell 1 basis point to 3.4% following the PPI data.
• The U.S. Dollar Index ($DXY) fell to a new two-month low of 101.2.
• The Cboe Volatility Index® (VIX) futures dropped to near their recent lows at 18.71.
• WTI Crude Oil (/CL) is down slightly at $82.85 per barrel.

Just In

Analysts had expected PPI to be flat month-over-month, and core PPI to rise 0.3%, Trading Economics says. PPI fell 0.1% in February and core PPI was flat.

PPI can generally indicate consumer price conditions, because rising wholesale prices often get passed along from companies to their customers. Also, PPI can be a useful indicator ahead of earnings season. If wholesale prices rose sharply, they potentially weighed on company margins.

In March, headline PPI mostly reflected sharp drops in the cost of energy, but those prices have flared up since then. The better news is that services prices dropped 0.3% in March, the largest decline since April 2020. This was driven partly by dropping costs for transportation and warehousing. Some food prices fell, including vegetables, but egg and meat prices climbed.

Delta (DAL) shares popped higher in premarket trading despite Q1 earnings and revenue missing Wall Street analysts’ estimates. Market participants appeared to latch onto the airline’s predictions of solid summer demand that could support profits down the road. Also, the CEO told reporters that the company was pleased with its Q1 performance, which he said was in line with DAL’s guidance. Yesterday, competitor American Airlines (AAL) warned that its Q1 profit might miss market expectations, and a Bank of America (BAC) analyst said airline bookings appear to be slowing, the Associated Press reported. Stay tuned for United Airlines (UAL) earnings next week

Eye on the Fed

The minutes from the March Federal Open Market Committee (FOMC) meeting show that Fed members saw economic risks “weighted to the downside” but also continued to fret about high inflation and a tight labor market. Despite the Fed’s 12-months of rate hikes, participants at the FOMC meeting observed that labor demand “continued to substantially exceed labor supply.” Wage growth, they said, is well above the level needed to get overall inflation back toward the Fed’s goal of 2%.

Fed policymakers’ projections, the minutes show, include a “mild recession starting later this year, with a recovery over the subsequent two years.” This language, along with the Fed’s continued inflation concerns, may have helped trigger selling that put the brakes on an early stock market rally yesterday. With earnings season yet to start, the market remains extremely sensitive to Fed news, but could become a little less so once there are some earnings to chew on.

The probability of a 25-basis-point increase next month was  64% this morning after the PPI data, according to the CME FedWatch Tool. All members of the FOMC agreed in March that a 25-basis-point rate hike was appropriate despite the recent banking crisis, according to the minutes. In fact, some officials would have considered a 50-basis-point hike if it hadn’t been for the bank failures that occurred just before the meeting began. Others had considered pausing rate hikes. They ended up meeting in the middle.

Cooper Howard, director of fixed income strategy at the Schwab Center for Financial Research, expects the Fed to hike rates one more time this year and then pause.

Stocks in Spotlight

Teller windows ready to open: Friday brings earnings reports from several of the nation’s biggest banks, including JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC). Bank of America (BAC), Goldman Sachs (GS), and Morgan Stanley (MS) report next week to round out the six largest U.S. banks.

Here are some things to keep in mind for each of the big banks reporting on Friday.

• JPM: Last time out, JPM kicked off earnings season by beating analysts’ Q4 earnings per share (EPS) and revenue estimates, helped by a positive tailwind from net interest income, which is the spread between the interest revenue banks generate from their loans and the interest they pay to depositors. The bank saw average loans rise 6% in Q4. Net interest could remain a tailwind for JPM in Q1. Another factor to watch is whether JPM adds additional loan loss reserves that eat into profits. In Q4, it posted a $2.3 billion provision for credit losses, up 49% from Q3.
• C: Citigroup saw a steep drop in Q4 profits as the company set aside more money for potential defaults on loans. The bank did enjoy strength in its services and markets divisions in Q4, however, with markets having a solid quarter driven by fixed income trading. The question is whether there’s follow-through in Q1. It’s possible considering recent market volatility that may have reflected heavy trading volume.
• WFC: In Q4, Wells Fargo experienced a nice lift from rising net interest income like many of its competitors. Expenses also fell. WFC is an interesting canary in the coal mine for the consumer economy because it’s been a leader in both home and auto lending. It’ll be important to check Q4 results in those categories for WFC and to hear executives’ views on how demand is shaping up.

What to Watch

Retail Sales: This important indicator of consumer demand fell 0.4% in February, and analysts expect a March drop in sales of 0.4%, according to consensus from Briefing.com.

If the number comes in as expected, it could provide more evidence that the economy is slowing down. Back in February, retail sales fell for many goods and services versus January. The mix of sales trends remains worth following. A steep February decline in food services and drinking places sales might have signaled consumers pulling back on eating out. Motor vehicle, clothing, and furniture sales also fell sharply in February, but keep in mind January was a strong month for those categories.

Sentiment check: If retail sales fell in March, it could reflect consumers getting a bit more conservative in their spending. Slower wage growth—which we saw in last week’s March jobs report—can affect consumer sentiment, and we’ll get a reading on that just after Friday’s open with the release of the preliminary April University of Michigan Consumer Sentiment report. Wall Street consensus is for a slight rise from March at 62.7, from 62.0. Still, that’s historically weak.

Follow you follow me: The so-called “mega-cap” tech stocks like Apple (AAPL), Tesla (TSLA), Microsoft (MSFT), Alphabet (GOOGL), and Meta (META) helped fuel the recent rally in major stock indexes like the S&P 500® index (SPX). Unfortunately, what the mega-caps give, they can also take away. Yesterday brought more evidence of that. When mega-caps lost ground Wednesday afternoon following the release of the Fed’s March minutes, the major indexes gave up their early gains and fell into the red.

Lasting impact: What are short-duration stocks and how might they perform if interest rates stay high? Jeffrey Kleintop, Schwab’s chief global investment strategist, explains in his most recent article.

CHART OF THE DAY: TECH OUTRUNS CHIPS: The S&P Technology Select Sector Index (IXT—purple line) is slightly outpacing the PHLX Semiconductor Index (SOX—candlesticks) so far 2023, though both are growing much faster than the overall market. Each has leveled off a bit in recent weeks. Data sources: S&P Dow Jones Indices, Nasdaq. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

Sector standings: There hasn’t been much change in market leadership recently. Communication services and info tech have led the way all year, with financials, industrials, and real estate bringing up the rear of the sector pack since mid-March. Perhaps that’s a reflection of the recent banking turmoil and its potential impact on commercial real estate and industrial companies if credit tightens and the economy slows. The financials sector has been particularly sluggish all year. Industrials, however, started 2023 with decent gains, only to lose ground recently as economic projections came under a cloud. Lockheed Martin (LMT) is expected to be the first major industrial firm to report Q1 financials next Tuesday.

Parsing portfolios: When big banks start reporting tomorrow, keep an eye on the general level of loan activity and the quality of their existing loans. If the quality of their loan portfolios is beginning to deteriorate and people are having trouble making payments, that could be a sure sign of a weakening economy. It might also reinforce views that banks are battening down the hatches as higher interest rates weigh on their businesses. The main thing to watch here is how much, if anything, they added to provisions for credit losses. More capital set aside for that indicates increased fears of default and also weighs on earnings. Check loan growth, too. For instance, JPM saw overall average loans up 6% in Q4—see what it looked like in Q1.

Crude intrudes: Could crude spoil hopes for price relief? Yesterday’s March Consumer Price Index (CPI) report showed headline inflation up just 0.1%. Coincidentally, CPI came out as WTI crude oil futures (/CL) raced toward 2023 highs above $82 per barrel following OPEC’s recent production cut. If this trend continues, CPI might not look as friendly in April, posing a fresh challenge to the Fed as it fights inflation. The problem with higher crude isn’t just at the gas pump. Crude fuels just about every major industry, meaning higher prices could affect many sectors. Transports like airlines, trucking companies, railroads, and shipping firms are particularly at risk and may see margins threatened. However, it’s possible some firms hedged when crude fell earlier this year to 15-month lows, which would have locked in their costs at lower levels. Also, CME crude futures are in backwardation, meaning prices for contracts further out this year are lower than the spot price. The market isn’t always right—but if it is, lower prices might be ahead.

Calendar

April 14: Expected earnings from BlackRock (BLK), PNC Financial Services (PNC), JPMorgan Chase (JPM), Citigroup (C), Wells Fargo (WFC) and UnitedHealth (UNH). March Retail Sales and April University of Michigan Preliminary Consumer Sentiment.

April 17: April Empire State Manufacturing and expected earnings from State Street Corp. (STT).

April 18: March Housing Starts and Building Permits and expected earnings from Bank of America (BAC), Goldman Sachs (GS), Johnson & Johnson (JNJ), United Airlines (UAL), and Lockheed Martin (LMT).

April 19: Fed’s April Beige Book and expected earnings from Abbott (ABT), Morgan Stanley (MS), and Travelers (TRV).

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

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