The Fed Announces Plans To Raise Rates And Reduce Balance Sheet, But Refuses To Get Tied Down To A Schedule

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(Wednesday Market Close) The Federal Open Market Committee (FOMC) ended its two-day meeting on Wednesday with its customary interest rate decision announcement and press conference. After the December Consumer Price Index (CPI) reported inflation grew at 7.1% year over year, the market started to expect the Fed to hike the overnight rate to 0.25% in March.

In the announcement, the Fed stated that it wasn’t going to raise rates. As far as rate-hike guidance, the Fed simply reiterated what it has said before, that it would “continue to adjust as needed.” In a separate announcement, the Fed said it plans to reduce its balance sheet after it starts hiking interest rates.

During the press conference, Chair Powell was unwilling to state whether the Fed would raise rates each meeting or every other meeting and that it basically wants to keep its options open. He did clarify that the committee would defer the decision to raise the overnight rate in March at the March FOMC meeting. So, the market has been projecting three to four rate hikes in 2022, but the Fed wasn’t willing to make that commitment. However, Powell didn’t rule out any of these possibilities, nor did he rule out raising rates more than a quarter point at a time. The Fed has stuck with quarter-point adjustments for more than two decades to keep a measured approach to interest rate changes.

As far as the economy, the Fed cited major improvements in economic growth and the labor markets since the pandemic. Powell noted that the labor market was in a historic situation where so many job openings were going unfilled and numerous workers were quitting. Mr. Powell also acknowledged higher inflation as an important factor, which is growing well above the Fed’s target of 2% per year. The chairman did reiterate the committee’s expectation that many of the supply chain problems will eventually iron themselves out as the economy slows its growth.

Stocks were quite volatile after the announcement. The S&P 500 (SPX) rallied higher and then sold off into negative territory. However, it also trimmed its losses to close just 0.15% lower on the day. The Dow Jones Industrial Average ($DJI) had another 800-point swing before closing just 0.38% lower on the day. The Nasdaq Composite ($COMP) also had major swings of its own ranging 600 points. But investors started buying technology stocks, leading the tech-heavy index to close basically flat for the day.

The 10-year Treasury yield (TNX) was relatively flat ahead of the announcement, trading around 1.785%, but rallied soon after, climbing to 1.848%, which is near its previous January highs. The Fed’s comments and rising yields pushed the dollar higher. The U.S. Dollar Index rallied 0.60%. 

Crude oil prices appeared to feel no threat from the Fed’s plan to attack inflation because it rallied more than 2.6% before the announcement and created a new 52-week high. However, the price of oil did pull off its high and closed at $86.98, which was still its highest close in seven years. The rally in crude also occurred despite an unexpected rise in oil inventories, according to the Energy Information Administration’s weekly crude inventory report. Higher crude inventories tend to be bearish for oil, but the Russia-Ukraine crisis appears to be overshadowing inventories.

Behind the Curve

Throughout January, the yield curve has seen major shifts, particularly on the low end. The 2-month yield rose 50%, the 3-month skyrocketed 138%, the 6-month shot up 77%, the 1-year grew 63%, and the 2-year rose 31%. The remainder of the curve experienced gains but diminished by maturity. Climbing rates on the short end of the curve reflects the market’s expectations that Fed will raise rates sooner.

The long end of the curve will likely be more influenced by the Fed when it starts to reduce its balance sheet by allowing bonds to mature without replacing them and selling bonds. The Fed was buying longer-term bonds as part of its quantitative easing program to provide liquidity throughout the yield curve and keep rates low. However, the Fed did make it clear that the overnight rate is its primary tool, and that over the long run, it hopes to only hold Treasuries and not mortgage-backed securities.

The rising short-term rates have continued to flatten the yield curve when looking at the 2s10s yield spread. Before the pandemic, the yield curve had already inverted, which is a precursor to a recession. The pandemic pushed the U.S. economy into a short recession, but the yield curve normalized and then steepened through April 2021. Since that time, the yield curve has been flattening but isn’t close to inverting.  

CHART OF THE DAY: AHEAD OF THE CURVE. The 10-year Constant Maturity Minus 2-year Treasury Constant Maturity (blue) is used to monitor changes in the yield curve. The curve steepened throughout the pandemic but started its flattening trend in April 2021. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Earned Runs

Earnings season continues to roll on with AT&T (T) reporting that it beat on revenue and earnings estimates despite a 10% drop in revenue from its satellite TV company DirecTV. The drop was somewhat expected as it relates to many other pandemic plays. The company rallied about 1% before the opening bell, but it drastically turned down and fell 8.42% after management gave confusing guidance that suggested the company would see only “low-single digit” growth in 2022. AT&T is merging its WarnerMedia business with Discovery (DISCA). DISCA also fell 9.16% on the day.

Boeing’s (BA) earnings nosedived after reporting a greater-than-expected loss and less-than-expected revenue. Analysts were aware of a number of write-offs that would lead to a loss, but they didn’t how big the write-offs would be. On the bright side, BA maintained its 2022 earnings outlook. Investors didn’t seem to know what to do with the news because the stock rallied and sold off, closing 4.82% lower on the day. 

After Tuesday’s closing bell, Microsoft (MSFT) reported great earnings and revenue but failed to grow its cloud business. However, MSFT management increased its 2022 revenue guidance and the stock rallied 2.85%. 

Texas Instruments (TXN) had a big upside earnings surprise, which prompted the stock to rally 2.51%. The news was welcomed by a beleaguered semiconductor group and TXN’s peers rallied on the news. The PHLX Semiconductor Index (SOX) rallied 1.68%.

After Wednesday’s close, more companies released earnings including Tesla (TSLA) and Intel (INTC), which announced better-then-expected earnings and revenue, but both companies dropped about 2% in after-hours trading. Las Vegas Sands (LVS) reported a larger-than-expected loss and missed on revenue too. Whirlpool (WHR) missed on revenue but was able to still report much better earnings. Both LVS and WHR were unchanged in after-hours trading.

Advancing Runners

Looking outside of earnings announcements, toymaker Mattel (MAT) has won the right to produce Disney (DIS) princess dolls that will be joining Mattel’s Barbie doll line. The move edges out rival Hasbro (HAS). MAT rallied more than 4% on the day, DIS fell 2.13%, and HAS dropped 6.06%.

Ford (F) was set to have a big day rallying more than 5% on news that JP Morgan analysts raised their price target on the company and maintained their “overweight” rating. However, the rally ran out of gas, and Ford closed just 0.35% lower.

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

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.

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