Fed meeting starts today with rate cut probabilities not as high
Crude eases slightly but analysts say more risk premium possible
FedEx reports later today while GM grapples with strike
(Tuesday Market Open): Things sometimes get sluggish on Wall Street when the Fed meets. Maybe not this time around as the Fed gathers today with geopolitical tensions still front and center. Where will we go next remains the question, with a lot of uncertainty in the air.
Markets held up amazingly well Monday in light of everything, though the Dow Jones Industrial Average ($DJI) fell for the first time in nine sessions. Stocks could enter a holding pattern for a bit here as people assess what’s going to happen next in the Gulf and wait for the Fed’s decision on rates tomorrow afternoon. Volatility hasn’t really moved much since late yesterday, with the Cboe Volatility Index (VIX) just below 15.
Crude slipped a little early Tuesday, but don’t count out the chance of it potentially going even higher as more risk premium gets built in after yesterday’s incredible 15% rally. More on crude below.
It was a mixed picture overseas Tuesday. Stocks plunged in China, where traders appeared to be reacting to disappointing economic data, but overnight action was pretty uneventful in other parts of the world. Everyone seems to be on edge waiting for the next shoe to drop, and the Fed meeting just adds to the intrigue.
A little earnings news could provide a welcome break today as both FedEx (FDX) and Adobe (ADBE) report. We’ll talk more about FDX below.
Before getting to the Fed and crude, there was an interesting note from Deutsche Bank this morning that said the S&P 500 (SPX) should be 13% lower because a recession is coming. So that’s something to keep in the back of your mind. It’s nothing definite, but it was an interesting little note.
Uncertainty Overseas and at FOMC
As uncertainty mounted in the Persian Gulf, it also climbed on the home front. For the first time, we’re seeing questions about whether the Fed will lower rates. Probabilities in the futures market have come down a bit, though it still seems likely the Fed will cut.
By early Tuesday, CME futures pegged chances of a 25-basis point rate cut at around 66%, down from 90% just a week or two ago. That’s a 34% chance of no cut. If the Fed doesn’t cut rates, that could potentially be a second blow this week for the stock market.
Rate cut probabilities could be falling in part because of how strong the market has been over the past few weeks. If the Fed doesn’t cut rates, we could see a sell-off, but if that happens it probably would just take us lower in the long-term range of between 2800 and 3000 in the SPX. We’ve been trading in the higher part of that range lately, so maybe lack of a cut would mean trading lower in the range.
Besides the rate decision, the Fed is scheduled to give investors its outlook for future rates with a new “dot plot” where members chart expectations. That’s probably the best way to get a sense of just how likely any future rate cuts might be and when they might come.
Slowing global economies, the trade war, and negative rates overseas all drove expectations for a rate cut this week. There’s still a high chance of that, but you can’t write off this uncertainty creeping in. A lot of Federal Open Market Committee (FOMC) members have said they’re against cutting rates, so maybe that’s getting worked into the market as the decision approaches.
The FOMC members who’ve spoken against rate cuts argue the economy isn’t sluggish enough to need more monetary stimulus. Some also say that the problem isn’t rates, but instead corporate uncertainty around tariffs that’s eating into business investment. The Fed can’t necessarily fix that.
The Fed also can’t do much about the situation in the Middle East and its possible effect. Though spiking crude prices raise inflation concerns, some analysts on Monday said the attack could actually be deflationary over the longer term if high crude prices slow the rest of the economy. If deflation starts to rear its head, that could make the Fed’s job even harder. Remember, like Sisyphus, it’s been trying to roll inflation back uphill for years but hasn’t consistently met its 2% target.
Assuming the Fed does lower rates, we’re not necessarily out of the woods. If Fed members come out Wednesday with a hawkish dot plot or post-meeting statement after a rate cut, don’t be surprised if the market reacts negatively. Fed Chair Jerome Powell’s press conference, as always, remains important to watch.
Crude Rallied—All the Way To Where It Was in May
Monday’s 15% jump in crude was the biggest for a single day since January 2009, back when crude was coming off multi-year lows during the Great Recession. That kind of dramatic headline was all over the media, and it’s certainly worth noting.
Still, what the headlines don’t tell you is that even with crude’s huge jump, prices just aren’t that high compared with where they’ve been. They’re not even back to last spring’s peak of around $66 a barrel for U.S. futures. The last time they were at current levels was in late May, less than four months ago. For now, these prices don’t look too hard to handle for many businesses and consumers. Look at American Airlines (AAL), which took it on the chin yesterday, falling over 7%. However, the move should be taken in context—even after the selloff, AAL shares are trading 15% above where they were a month ago.
Crude’s rise also might solidify ideas that the U.S. is a bit insulated from some of the world’s problems. More expensive crude could hurt the U.S. economy, but with the U.S. now the world’s biggest crude producer and a large exporter, the effect is less than it would have been 10 years ago, analysts point out. In fact, this current crisis might reinforce investor sentiment that the U.S. is, as Briefing.com puts it, the “best house in a deteriorating neighborhood.”
Speaking of that, China issued some weak economic data early this week that kind of got overlooked amid the Middle East situation. Arguably, if it hadn’t been for those Gulf fireworks, the China news could have weighed on stocks. China’s industrial production grew at the weakest pace in more than 17 years last month, Reuters reported. This weighed on industrial metals prices, including copper.
Patterns Hard to Decipher
The big question Monday after the attacks on Saudi Arabia over the weekend was where would investors go? Would the rotation into value, small-cap, and cyclical stocks that began last week continue? Or would people hide out in markets like bonds, gold, and “defensive” stock sectors where they conceivably thought they’d find protection from stormy geopolitical weather?
Well, after one day, the answer is a little of everything. Small caps continued heading up Monday, in part because of the many energy names in the Russell 2000 (RUT). Bonds also got a bid, and gold climbed more than 2%, not all that surprising considering gold is often the place people look when uncertainty strikes. Defense contractor stocks rose (see more below), and so did volatility (though maybe not as much as some might have expected).
In what probably came as a surprise to few, Energy stocks had the biggest day Monday, climbing 3% as crude prices made a historic leap (see more below). Other sectors that managed to gain were traditional “defensive” ones like Utilities and Real Estate—the very ones many investors had been selling last week.
Materials and Consumer Discretionary lost the daily popularity contest. Not too surprising, either, considering consumers would feel the first icy chill of any spike in gas prices, which could limit their desire to make new discretionary purchases. This remains worth a close watch.
FedEx Earnings Could Shed Light on Consumer
The earnings calendar is light this week, but FedEx (FDX) helps break up the monotony after today’s close. It’s been a tough last two years for FDX investors as the stock has wilted. People often see FDX as a barometer for consumer demand, making it interesting to watch. It also might be interesting to hear any observations on this new spike in crude prices and how that might affect the company’s business.
In other corporate news, General Motors (GM) could lose as much as $100 million a day if the nationwide strike of auto workers goes on, the Wall Street Journal reported. Car industry analysts estimate that the strike could dent the company’s profit by between $50 million and $100 million daily.
FIGURE 1: POW! It’s not often that you see a 15% one-day rally in the most closely-watched commodity market in the world, but it happened Monday. This three-day chart shows how U.S. crude oil futures (/CL-candlestick) were humming around late last week in the middle of the long-term trading range near $55 a barrel before Saturday’s attack on Saudi Arabia sent prices to their biggest one-day gain in more than 10 years. Data Source: CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Getting Defensive: When sabers rattle, defense contractors tend to benefit. This time is no different. Both Lockheed Martin (LMT) and Raytheon (RTN) shares started the week with decent gains and approached their highs for the year as worries mounted about possible military action in the Middle East. While some investors loaded up on defense contractor shares, others seemed less wary. The Cboe Volatility Index (VIX) hung around near the 15 level, not far from recent lows. If expectations for an oil-related war were really elevated, you’d think VIX would have showed more reaction. This could be because people have gotten used to big headlines from the Persian Gulf followed by the situation blowing over. It might be more important than usual this week to keep an eye on the VIX, because sudden spikes in volatility could reflect growing geopolitical concerns in real time.
Talk to the Boss: One worry with unemployment below 4% for so long is the chance of a tight labor supply leading to higher wage demands leading to inflation. The job market lately has been so good that CNN reports this week that new hires sometimes aren’t even showing up on the first day of their jobs—something better came along and they simply “ghosted” their employer.
Still, it hasn’t had a big impact on inflation—so far. The Consumer Price Index (CPI) for August rose just 0.1%, though it was up a moderate 2.4% year-over-year when you strip out volatile food and energy prices. Still, the Fed’s favored Personal Consumption Expenditure (PCE) prices data have been below the Fed’s 2% inflation target for months. So inflation is pretty subdued. One reason could be that despite low unemployment, wages just aren’t rising as much as they did in past periods when job growth was this strong. Higher wages can sometimes cause inflation to flare as producers pass along extra costs. Wages have grown just over 3% year-over-year for a while now, but haven’t regularly topped 4% the way they did in past recoveries.
Agree to Disagree: Executives and analysts sometimes get into disputes, but rarely so publicly as what we saw last Friday between Goldman Sachs (GS) and Apple (AAPL). After GS issued a note saying AAPL’s one-year trial of its new TV+ service would hurt the company materially, and lowered its price target, AAPL responded in a statement to CNBC, saying: “We do not expect the introduction of Apple TV+, including the accounting treatment for the service, to have a material impact on our financial results.”
The stock, down more than 2% before the statement, appeared to get a slight boost afterward, but still finished the day well off its weekly highs. Goldman isn’t accusing Apple of improper accounting, CNBC reported, but believes that hardware profit margins will suffer as a result of the TV+ free trial and that investors will react negatively. As for who’s right—AAPL or GS—it could take time to figure out, but that’s the great thing about markets. We might not agree all the time, but we hopefully get to see what happens if we wait long enough.
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This week’s economic calendar. Source: Briefing.com