Decision Time: Rate Hike Looks Likely Today Despite Market's Struggles

(Wednesday Market Open) If anyone’s ever had to thread the needle, it’s arguably Fed Chair Jerome Powell when he steps to the podium after today’s Fed meeting.

Whatever step the Fed takes on rates (futures prices puts odds of a hike at 71%), Powell will probably have to choose his words very carefully to keep the market from getting more nervous. He’s got to calm the children, so to speak. 

If Powell makes it sound like the economy is weak, that could reinforce some of the current negative sentiment and potentially drive the market lower. If he sounds too optimistic about the economy, that could potentially be interpreted as hawkish and drive ideas that more hikes might be on the way next year...which could reinforce current negative sentiment and possibly drive the market lower. If you’re Powell, either way, there’s a chance you could lose.

A middle ground—in which Powell and other Fed officials convey that the economy remains strong but  the Fed can ease off and see if the numbers continue to back that up—might be the most market-friendly approach. We’ll have to wait and see what Powell says in his press conference and what the statement from the Fed tells us at 2 p.m. ET today. 

While the futures market still dials up about a 30% chance of no hike, that wouldn’t necessarily be positive for stocks. In fact, it might be a shock to the system, with a really negative impact. The market generally expects a rate hike, and if it doesn’t get what it expects, that could be read as disappointing. Chances are that would potentially hit stocks pretty hard. People might interpret an unexpected rate pause as a sign that the Fed sees underlying weakness in the economy that others may not.

The other potentially major thing to watch is the “dot-plot.” The last one, in September, projected about three rate hikes next year. The futures market now gives 50-50 odds of none at all. It seems like something’s got to give, but will it be the Fed or the market? Some analysts think the Fed might indicate just two rate hikes in 2019, or even fewer. 

We’ll be back after the decision with analysis, along with some thoughts on Powell’s press conference. Stay tuned.

Crude Sends Chill

When stocks sank in early 2016, crumbling crude prices looked to be a big factor. Like a canary in a coal mine, the value of industrial commodities such as crude and copper often can hint at bigger economic problems that might be festering, simply because demand for them tends to fall when the economy slips. 

The same thing seems to be happening now. U.S. crude futures plunged more than 8% at one point Tuesday to below $46 a barrel just two months after climbing to four-year highs above $76. If someone had told you in early October that crude would fall by $30 over the next two months, you probably would have been right to predict problems for the stock market. Though weak crude can help some sectors, as seemed to be the case Tuesday for transports (see more below), it also can send a chill.

Energy stocks got hammered Tuesday, which doesn’t seem too surprising on a day when oil fell so sharply. Crude steadied a bit early Wednesday, but at low levels just above $46.

A Few Positives

The market’s early big rally yesterday ended up looking a bit like a “pump fake,” to borrow a basketball term. Markets pulled back in the final hours, even going negative for a bit, before finishing just a little higher. The big slide in crude, which arguably hadn’t been expected, probably hurt sentiment as the session advanced, raising more questions about the health of the economy.

Some relief might have initially come Tuesday amid reports that the White House was backing off its previous talk about a partial government shutdown. Though shutdowns haven’t had a huge market impact in the past, any signs of discord in Washington as Democrats prepare to take power in the House has the potential to add to frayed nerves on Wall Street. By later in the day, however, media were reporting more disarray on the budget, meaning uncertainty remains about whether all agencies of the government can remain open after this week. 

Also on the positive side, transport stocks took wing Tuesday, with shares of American Airlines Group Inc. AAL, United Continental Holdings Inc. UAL, Alaska Air Group, Inc. ALK and Southwest Airlines Co.LUV all on the climb amid the steep drop in crude oil prices. The Dow Jones Transportation Average ($DJT) outpaced the broader market  as some analysts saw possible margin improvements for many transport companies assuming weak crude prices persist.

In addition, the FAANG stocks seemed to hold up a little better Tuesday, and Visa V and Mastercard Inc. MA climbed as well. Both V and MA can sometimes give good insight into consumer health, partly because they give consistent readings no matter what stores go in and out of popularity. Also, the iTunes Store at Apple Inc. AAPL is quite reliant on purchases through those two cards, making them a decent barometer for part of the tech market. There are other payment mechanisms out there, but V and MA look like the two big dogs in the room, at least when it comes to iTunes.

Nasdaq (COMP), which a lot of the more “risk-on” kind of stocks call home, outperformed the other major indices Tuesday. That might be seen as a potentially bullish sign, but it’s just one day.

Getting back to transports for a moment, $DJT component FedEx Corporation FDX reported after the close Tuesday with more news that seems like it could potentially add to the bearish mix. Shares fell 5% in post-market trading when FDX trimmed its 2019 earnings guidance. FDX, like V and MA, is sometimes viewed as kind of a bellwether for consumer demand.

S&P 500 futures fell hard after the FDX guidance, but the company’s comments on the call with analysts are worth noting. FDX said it still sees strong U.S. demand, but a global slow down. The question is whether that slow down makes it to U.S. shores.

Data, outside of the Fed decision, is a bit light today. Existing home sales for November looks like the main economic number to consider taking a look at. Meanwhile, the question is whether early positive sentiment on Wall Street can last. Investors have been fooled lots of times lately by early rallies that ended up going nowhere by the day’s end.

China Tariffs Still the Elephant in the Room

It’s been a bit quiet lately on the China negotiations front, but Chinese President Xi Jinping might have disappointed some investors with a speech yesterday that didn’t spend much time on economics. Some analysts had hoped Xi would use the speech to mention liberalizing the economy or easing trade tensions, The New York Times reported, but that didn’t happen. One comment Xi did make was that China wouldn’t “abandon its own legitimate rights and interests,” which doesn’t exactly sound like any promise of a trade thaw.

Whatever the Fed does today, it’s arguable that Fed policy is just “Story 1A,” with tariffs still the overarching story. Many investors feel uncertainty because it’s unclear what the rules of trade might end up being between the world’s two largest economies. Uncertainty, history shows, is often a bearish factor.

Figure 1:  Who’s Leading Whom? A look at this year-to-date chart of the S&P 500 Index (candlestick) vs. U.S. crude (blue line) shows how it looks like crude might have helped lead stocks both up earlier this year and down more recently. The fortunes of crude and the SPX seem more tied together lately than say, a year ago. Data Source: S&P Dow Jones Indices, CME Group. Chart 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.

Dollar, Treasuries Pivot While Awaiting Direction From Fed: As stocks got wrestled down Monday and then popped back up early Tuesday, the dollar index didn’t go very far. It’s been pivoting around 97 for a few days, still near its highs for the year but not yet making any new ones. Recall that it fell well below 90 early in 2018. The drop under 97 early Tuesday might have helped play a role in the stock market’s slight revival. The Fed’s tone today could conceivably have an impact on the dollar, with any dovish language or rate prognostications very likely to help give the greenback some direction. Meanwhile, it wouldn’t be too surprising to see the dollar continue to wobble today ahead of the decision. 

Meanwhile, over in Treasuries, 10-year yields also pivoted around the middle of their range early this week as the old 2.8% to 2.9% area that was such a common reading last summer seems to be back in vogue. The closely-watched gap between the 2-year and 10-year note rose slightly to around 17 basis points by Tuesday, up from as little as 13 at times last week. As the risk-off sentiment appeared to pick up late in the day, the 10-year yield fell back toward recent lows at 2.82%.

If the Fed sounds dovish today, it’s possible that the yield gap might grow, partly because shorter-term yields tend to be more attuned to Fed policy. Any sign of the Fed retreating from that in 2019 might conceivably put pressure on the short-term term yields. The narrowing yield gap has been one factor contributing to investor concerns lately, as in the past it’s sometimes been associated with recessions.

Happy Housing Headline Hides Shaky Foundation: A quick glance at the headline housing numbers early Tuesday might have given investors a sense that November saw strength. After all, both building permits and housing starts rose sharply from October, with housing starts at a seasonally adjusted rate of 1.256 million coming in well above analysts’ consensus. A deeper dive into the data, however, arguably showed that the report’s glossy exterior rested on a shaky foundation. Total starts increased 3.2%, but starts for single-family units declined 4.6% to 824,000, the lowest since May 2017. At the same time, multi-family housing starts surged as rental demand climbed. So the takeaway could support the contention that U.S. consumers are pretty enthusiastic about making short-term purchases, like for Christmas, but less excited about spending for the long-term on big items like cars and houses. Rising interest rates could be hurting single family home construction, as well, Briefing.com pointed out.

Could Fed Get Crude? Today’s U.S. crude stockpiles weekly report might be overshadowed by the Fed, but it’s worth watching when you think about the Fed’s inflation outlook. Back in 2014 and 2015, huge supplies of petroleum helped shatter prices and probably played into low inflation that allowed the Fed to put off raising rates a while longer than some analysts had originally expected. Today, the same dynamic might be at work, maybe giving the Fed a bit more runway to keep its hands off the rate-hike lever in 2019. 

As of earlier this month, the U.S. was sitting on 442 million barrels of crude, the government said, about 7% above the five-year average for this time of year. Meanwhile, Russian crude production is at record levels above 11 million barrels a day and U.S. shale alone accounts for eight million barrels a day. U.S. gas prices fell for the 10th straight week, dropping 5 cents to $2.36 a gallon, according to GasBuddy.com, a gas price-tracking site. That’s down from nearly $3 back in May. Some stations are selling gas for less than $1.70 a gallon. The Fed’s favored inflation tracking tool—Personal Consumption Expenditure (PCE)—for November is due Friday, but probably won’t reflect the depth of the gas price plunge since that month. It’s likely, however, that the Fed will be thinking today about how gas prices might keep inflation from flaring if oil producers keep their collective foot on the pedal.