Stocks briefly wobble, then rally after Fed raises rates 25 basis points, keeps language hawkish
Fed acknowledges inflation fight progress but still calls prices ‘elevated’
8th Fed rate hike in a row, but no sign of a pause ahead in March
Shawn Cruz, Head Trading Strategist, TD Ameritrade
(Wednesday Post-Fed) The Federal Reserve is taking the stairs down one step at a time. Today’s 25-basis-point rate hike was half of December’s, which was down from the record-setting four 75-basis-point increases from June through November. Stocks overcame an initial stumble and moved higher by the close.
While that upstairs rate climb helped make 2022 a year most investors would like to forget, so far, 2023 has been more fruitful. That said, today’s unanimous FOMC decision takes the Fed’s target rate to between 4.5% and 4.75%, a new 15-year high.
Stocks initially extended losses after the decision while Treasury yields rose, but then things reversed course and major indexes gained while yields fell, suggesting investors might be hoping the peak of the rate-hike cycle is approaching. The S&P 500 index (SPX) closed above 4,100 for the first time since late August and above the peak close of its November – December rally, possibly a meaningful and positive technical development.
A few quick takeaways:
- According to the Fed’s statement released with today’s decision, ongoing rate increases will be appropriate to get policy restrictive enough to return inflation to the Fed’s target of 2% over the long run. This is important, as the plural “increases” suggests multiple hikes going forward, while the Fed funds futures market is still only pricing in one more rate hike.The statement also noted that inflation has eased somewhat but remains elevated. In other words, the fight against inflation isn’t over yet.Fed projections for a peak rate in the 5% to 5.25% range and market expectations for a peak rate of just 4.9% are still in disagreement. As long as that gap remains wide, volatility could pick up.
In sum, the Fed’s foot remains on the brake.
Wall Street wavers
Stocks initially took a step back in the wake of the decision, possibly due to the Fed saying it still sees the need for “ongoing increases in the target range.” Many market participants might’ve been hoping for hints at a hiking pause, but that phrase promised the opposite.
“We have more work to do,” Fed Chairman Jerome Powell said in his post-meeting press conference, explaining that the Fed remains committed to its 2% inflation goal. “We will stay the course until the job is done.” He added, “We’re talking about a couple more rate hikes,” but more could be necessary depending on data.
Powell said he still sees lack of progress in the fight against inflation in the services sector, though what he called the “disinflation process” has begun in goods and should be on the way in housing.
After the initial drop in stock prices, the Nasdaq Composite® ($COMP) moved into positive territory and the Dow Jones Industrial Average® ($DJI) trimmed some of the steep losses it had piled up ahead of the decision. By an hour after the decision, the SPX was back above 4,100 and close to recent highs, while the 10-year Treasury yield (TNX) had fallen 10 basis points to 3.4%, near recent lows.
The Fed’s not promising a pause, but the easing size of recent hikes indicates some progress in the inflation fight over the last six months. Recent Producer Price Index (PPI) and Consumer Price Index (CPI) data looked benign, employment cost growth is slowing, and manufacturing appears to be in contraction. Some sectors, especially housing, are seeing the impact of higher rates, according to Powell.
The Fed also acknowledged price progress in its statement, saying in fresh language that inflation “has eased somewhat” but maintaining its previous wording that inflation “remains elevated.” Reducing it could mean softening of the labor market and below-trend growth, Powell noted.
Labor market under microscope
Labor is front and center for the Fed as it contemplates next steps. The failure of job growth and wages to appreciably slow despite the eight rate increases since last March could be the main reason the Fed promises to keep raising rates. “The labor market remains extremely tight,” Powell said. “The pace of job gains has slowed and nominal wage growth has shown some signs of easing but the labor market continues to be out of balance.”
The question now is how many more hikes are in the Fed’s quiver and to what level. Powell promised to continue watching the data and said it’s possible rates could move above the Fed’s terminal, or peak, rate projection from December.
As a reminder, in December, the Federal Open Market Committee (FOMC) projected a terminal rate of between 5% and 5.25% sometime this year. The futures market, on the other hand, came into Wednesday expecting rates to top out between 4.75% and 5%, with less than a 40% chance of rates ever getting to 5% or above, according to the CME FedWatch Tool going into today’s meeting. Those numbers didn’t move much immediately after the decision (see more below).
The market’s more dovish expectations could be one factor contributing to a nice rally in stocks to start the year accompanied by some strength in bonds.
The follow-up to the “how high” question is, “for how long?” The market expects a pause, possibly followed by rate cuts later this year. The Fed has repeatedly told the market it needs to be far less optimistic. Powell said so again in his press conference today, stating basically that the Fed doesn’t think rates are high enough yet and need to continue rising. In answering one reporter’s question at the press conference, Powell wouldn’t commit to a rehash of the Fed’s old policy of raising rates one meeting and pausing the next.
More data to mull
Before the Fed concluded its meeting Wednesday, investors received another burst of data. Combined, the numbers presented a decidedly mixed view of economic conditions that possibly complicates the Fed’s path even further.
For instance, December Construction Spending fell 0.4%, well below Wall Street’s expectations for slight growth. Yet to muddy the waters, the November figure got revised upward to growth of 0.5% from the prior 0.2%. The takeaway is probably that high rates continue to weigh on housing, but that uptick in November just when mortgage rates peaked is a bit of a head scratcher.
U.S. factory activity measured by the Institute for Supply Management (ISM) remained in contraction mode during January for the third-straight month, as the headline reading of 47.4% was below expectations for 48%. The prices paid and new orders components of the report both looked weak too, suggesting rate hikes might be doing their job.
What, then, should investors make of a December Job Openings and Labor Turnover Survey (JOLTS) report showing job openings rose to above 11 million for the first time since last summer, up from 10.4 million the prior month? It would be hard to draw up less Fed-friendly data, especially because the Fed is laser-focused on keeping wage growth from taking off. When job openings grow this fast, it suggests employers might have to pay up for talent, and the JOLTS “quit rate” also has remained pretty high recently, suggesting employees see lots of demand for their services.
All of this popped up just hours before the Fed’s decision, and even if it didn’t influence the FOMC’s thinking immediately, it’s bound to get attention in days and weeks to come, so will Friday’s January jobs report, which analysts believe will show jobs growth at a restrained 190,000.
Today’s JOLTS reading might mean that a stronger-than-expected jobs growth number Friday could get significantly get more shade from investors worried about the wage impact.
Here’s how the major indexes performed Wednesday:
- The $DJI closed 7 points higher at 34,092.The $COMP rose 2% to 11,816.The Russell 2000®(RUT) rose 1.36% to 1,958.The SPX climbed 42.6 points, or 1.05%, to 4,119, the highest close since August 25.
CHART OF THE DAY: STOCKS UP, YIELDS DOWN. Within an hour of the Fed’s rate hike, the S&P 500 (SPX—purple line) moved to new highs for the session, while the 10-year Treasury yield (TNX—candlesticks) headed back toward recent lows. Data sources: S&P Dow Jones Indices, Cboe. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.
Heading into Wednesday’s Fed decision, the CME FedWatch Tool put chances of a 25-basis-point hike at nearly 100%. The probability of another 25-basis-point hike in March stood near 84%. Shortly after the Fed’s statement and rate decision today, odds of a March hike stood at 86%, with only a 13% chance of a pause. But more importantly, today’s FOMC decision helped shape impressions of Fed policy further down the road. The market now prices in chances closer to 50% of rates eventually rising above 5% this year. A divergence between market expectations and hawkish Fed talk has long been a feature of the market, and that’s helped shape recent pullbacks in short-term Treasury note yields, which are most sensitive to Fed policy. The 2-year Treasury yield, for instance, fell below 4.2% early Wednesday after nearly touching 4.9% in early November. This coincided with the futures market factoring a likely Fed rate pause by midyear and even potential rate cuts before the end of the year. The 2-year rose to 4.23% immediately after investors got a look at the Fed’s statement, but the longer-term 10-year remained under 3.5%, roughly where it began the day. A widening yield curve could signal growing fears that the Fed could hike the economy into recession. Keep an eye on that metric.
Notable calendar items
Feb. 2: December Factory Orders and expected earnings from Apple (AAPL), Amazon (AMZN), and Alphabet (GOOGL)
Feb. 3: January Nonfarm Payrolls and expected earnings from Sanofi (SNY) and Cigna (CI)
Feb. 6: Expected earnings from Cummins (CMI) and Tyson Foods (TSN)
Feb. 7: December Trade Balance and Consumer Credit and expected earnings from BP (BP), Centene (CNC), and Hertz (HTZ)
Feb. 8: December Wholesale Inventories and expected earnings from Bunge (BG), Uber (UBER), and Yum Brands (YUM)
Feb. 9: Weekly Initial Jobless Claims and expected earnings from AbbVie (ABBV), AstraZeneca (AZN), Baxter (BAX), and PepsiCo (PEP)
Feb. 10: University of Michigan February Consumer Sentiment and expected earnings from Enbridge (ENB) and Honda Motor (HMC)
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