Fed Takes First Steps To Combat Inflation — Oil Looks To Strike Back

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(Thursday Market Open) Stocks are hoping to stay in the green this St. Patrick’s Day as investors try to build on a two-day rally. Despite the Fed’s much more hawkish stance, stocks rallied on Wednesday as if investors had just found a pot of gold. While gold futures rallied 1.74% before the market open on Thursday, so did other commodities­—including oil, which was up about 6% before the opening bell. The rise in commodities could be a drag on the stock rally. There are also a couple of economic and earnings announcements that could move the markets as well.  

Potential Market Movers

There was good news for the housing market: building permits and housing starts came in higher than expected for February, but only because the decline of 1.9% was smaller than the projected decline of 2.6%. Permits and starts were also lower than a year ago. Nonetheless, buyer demand appears to remain relatively strong.

Homebuilder Lennar (LEN) may welcome the good news around permits and starts because the company reported a miss on earnings after the close on Wednesday. However, it did beat on revenue. The company was hurt by supply chain issues, building costs, and rising mortgage rates.

In other economic news, the initial jobless claims were lower than expected, and continuing jobless claims also fell, signaling that more people are finding jobs. The Philadelphia Fed Manufacturing Index was also much stronger than expected, which means manufacturers received an increase in orders. The higher number of orders is good for manufacturing but also good for transports because these products have to be moved.

A couple of retailers also reporting earnings. Williams-Sonoma (WSM) and Dollar General (DG) both beat earning estimates but missed on revenue. Both stocks were trading higher in premarket action with WSM rallying 7.78% and DG climbing 2.96%.

Reviewing the Market Minutes

The Fed has finally begun its attack on inflation this month by ending its bond-buying program, aka quantitative easing (QE), and now raising rates. Chairman Jerome Powell spent the afternoon explaining what the Fed was seeing that led them to this point. 

In the official statement accompanying the announcement, the Fed said that it anticipates ongoing increases as needed. It also said it would begin to reduce its holdings of U.S. Treasury securities, agency debt, and agency mortgage-backed securities in the next meeting in May. All but one committee member was in favor the rate hike; St. Louis Federal Reserve President James Bullard wanted a higher increase to 0.50%.

The Fed also boosted its inflation forecast higher than expected. Economists were forecasting increased inflation in the core Personal Consumption Expenditures (PCE) price index at 3.5%. However, the Fed went further by projecting core inflation growing at 4.1% and overall inflation growing at 4.3%. The Fed is projecting a better inflation picture with the PCE index around 2.6%, which is still above the Fed’s target of 2%.

Considering these higher inflation projections by the Fed, the new projections have rates rising to 1.875% by the end of 2023 and holding through 2024. If this is the case, and assuming the Fed would stick with quarter-point hikes, then the Fed would have to raise rates in every meeting through the remainder of the year and three or four more in 2023. This is a much faster pace than the Fed had originally planned.

These hikes would be a tremendous balancing act between fighting inflation and keeping the economy growing. It’s a difficult act because the Atlanta Fed GDPNow tool is forecasting U.S. gross domestic product (GDP) for Q1 to be at 0.5%. Last week, Goldman Sachs (GS) downgraded its forecast for the U.S. economy and increased the likelihood of recession because of rising commodity prices, falling consumer spending, and tightening financial conditions that may restrict business access to capital. GS analysts are projecting the economy to grow at 1.75% for the year, which is below the consensus estimate of 2.75%.

However, in the press conference after the announcement, Mr. Powell said that he didn’t think there was an “elevated” risk of recession because of the amount of liquidity among households and businesses. Additionally, the Fed sees a lot of strength in the labor markets, which gives the committee some leeway to raise rates faster. The Fed did moderate its projection of GDP growth to 2.8% for the year due to the Russian invasion. 

Stocks fell after the announcement but rallied on Powell’s projections for GDP which were not as low as investors had feared. The S&P 500 (SPX) closed above its resistance level of 4,300 while rallying into the close. The Nasdaq Composite ($COMP) also had a big day, rallying 3.77% and moving back above its May lows. The two-day rally in the Nasdaq has taken the index out of bear market territory as it’s now 16% from its all-time high. 

CHART OF THE DAY: BANKING TURN. The PHLX KBW Bank Index (BKX—candlesticks) has underperformed its sector when compared to the Financial Select Sector Index ($IXM—pink) and the S&P 500 (SPX—blue). Data Sources: ICE, 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

Banking on Yields: The yield curve dramatically flattened right after the Fed announcement with the 2-year Treasury yield climbing to 2% from 1.85%. The 10-year Treasury yield (TNX) jumped initially to 2.24% and then went back to its previous intraday level. As trading moved forward, both maturities saw their respective yields fall. The 2-year yield closed around 1.924%, while the 10-year yield closed at 2.188%. In the end, the yield curve as measured by the 2s10s was lower on the day at 0.24 compared to 0.30 on Tuesday.

If the yield curve continues to flatten it could signal that the Fed is wrong on its economic growth projections. You may recall that when the 2s10s spread goes below zero it signals an inverted yield curve which has historically been a harbinger of a recession.

Banking on Yields: The financials sector rose on the news because they normally benefit from rising interest rates because of the increased spread between savings and loans. In fact, the PHLX KBW Bank Index rallied 3.19% on the day. Signature Bank (SBNY) was the top performing bank in the S&P 500, rallying 8.66%. It was followed by SVB Financial Group (SIVB), which rallied 5.72%, and First Republic Bank (FRC), which grew 5.21%.

After rallying hard after the first of the year, bank stocks have underperformed the sector and the overall market despite ongoing expectations of higher interest rates. One issue has been the worsening economic picture. Higher rates aren’t helpful to banks if people don’t want to borrow. Additionally, rising rates will likely reduce the refi market, which has become a bigger portion of the banking business in the previous decade as interest rates have continually gone lower. According to CNBC, mortgage applications and refinance home loans were down by about half compared to a year ago in January.     

Trucking Along: The Dow Jones Transportation Average ($DJT) had a huge day on Wednesday, rising 5.51%, and is now about 4% from its all-time highest closing price. The big move in transports will likely be seen as a positive sign for the economy because many investors use transportation stocks as a measure of economic strength.

J.B. Hunt (JBHT) was a leader in the convoy, shooting up 9.59%, but it was still behind Avis Budget (CAR), which rallied 21.53%. United (UAL) was the top airline in the transports index, rallying 7.71%; it has soared more than 17% in the last three days.

Notable Calendar Items

March 18: Existing home sales  

March 21: Nike (NKE) earnings

March 22: Adobe (ADBE) earnings

March 23: New home sales, General Mills (GIS) earnings, H. B. Fuller (FUL) earnings, KB Home (KBH) earnings

March 24: Durable Goods Orders

Image sourced from Unsplash

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