Fed Seen Hiking Again, But What's Its Next Step? Trading Could Be Subdued As FOMC Meeting Begins

(Tuesday market open) Cue up the Jeopardy theme music as the entire market waits for tomorrow’s Federal Open Market Committee (FOMC) rate decision.

Beyond that, there’s new urgency around the debt ceiling this morning after Treasury Secretary Janet Yellen said the United States could default on its debt as soon as June 1 if Congress doesn’t act. While this will likely be resolved before any deadline, as it has in the past, it is still something to monitor, especially as June approaches.

It wouldn’t be surprising to see stocks and Treasuries trade in a narrow range today and early tomorrow ahead of the Fed’s decision and Fed Chairman Jerome Powell’s press conference Wednesday afternoon. Bullish investors may be hoping Powell’s remarks include some indication of a pause in rate hikes ahead, but be prepared for him to remain steadfast in targeting inflation.

Recent economic data may have the Fed worried, as employment costs, construction spending, and the prices index of yesterday’s Institute for Supply Management (ISM) April Manufacturing report all were above Wall Street’s expectations. Taken together, the numbers suggest inflation is far from tamed.

Morning rush

• The 10-year Treasury note yield (TNX) fell 4 basis points to 3.53%.
• The U.S. Dollar Index ($DXY) climbed to 102.2.
• The Cboe Volatility Index® (VIX) futures edged up to 16.17.
• WTI Crude Oil (/CL) eased to $75.51 per barrel.

The 10-year Treasury yield climbed sharply Monday to a nearly two-week high ahead of the FOMC meeting. This could reflect some of the better economic data seen in recent days, and probably was one factor putting a brake on yesterday’s early rally in stocks.

Just in

Layoffs are back in the news this morning after Reuters reported that Morgan Stanley (MS) plans to cut 3,000 jobs in Q2. Slow dealmaking and a tough economic environment led to the decision, the news agency reports.

Eye on the Fed

As of this morning, the probability of a 25-basis-point rate hike stands at 94% according to the CME FedWatch Tool. The FedWatch Tool now works in about a 65% chance that the Fed will raise rates in May and then pause at the June meeting. There’s a 31% probability of another hike in June, according to the tool.

Even the FOMC can’t look into the future, but this week’s meeting is particularly inconvenient from a timing perspective, coming just two days before the April Nonfarm Payrolls report. Analysts expect the report to show job creation of 180,000, Trading Economics says. That’s down from 236,000 in March.

“The Fed is expected to raise rates by 25 basis points on Wednesday and may signal that it will pause once it has gotten the fed funds rate above 5% and switch to the ‘hold’ part of its ‘hike and hold’ strategy,” the Schwab Center for Financial Research says in a report Monday.

“However, with inflation readings still coming in on the upper end of expectations, there is a risk that the Fed retains some of the language about inflation and growth running too strong. The phrase to look for from the Fed is, ‘some additional policy firming.’ That would signal that the Fed is leaning toward more rate hikes and would likely be negative for the bond market.”

Expect the Fed to also address recent bank jitters, notably JPMorgan Chase’s (JPM) acquisition this week of First Republic Bank (FRC), a regional lender that struggled to emerge from the turmoil that engulfed parts of the banking sector in March.

What to Watch

There’s one final data point on tap before the Fed decision. The March Job Openings and Labor Turnover Survey (JOLTS) report is due after today’s open, and analysts expect it to show 9.775 million jobs that need to be filled, according to consensus from Trading Economics.

That would be down from 9.931 million in February and might be welcomed by investors hoping that labor market tightness is easing. A trend in that direction could ultimately make the Fed’s job easier by reducing wage inflation. To put things in perspective, however, 9.7 million is about 50% higher than the typical JOLTS figure seen in the years leading up to the pandemic, making it very elevated historically.

Keep an eye on the “quits” rate, as well. Falling quits would likely indicate employees seeing less opportunity to move from position to position—another sign of a slowing jobs market.

Stocks in Spotlight

About 20% of S&P 500® companies report earnings this week. The highlight is Thursday afternoon when Apple (AAPL) opens the books, but other major reports include Kraft-Heinz (KHC), Advanced Micro Devices (AMD), Pfizer (PFE), Uber (UBER), Ford (F), Starbucks (SBUX), Marriott (MAR), and Anheuser-Busch (BUD).

Here are some highlights from this morning.

Pfizer: Shares rose in premarket trading despite a large year-over-year drop in sales due to declining demand for the company’s COVID-19 vaccine. Earnings per share and sales topped Wall Street’s estimates in a quarter with tough comparisons to a year ago due to the easing of the pandemic. Investors on PFE’s call should consider listening closely for pipeline updates.

Uber: After a three-month skid, shares of the rideshare company rebounded in premarket trading this morning as investors reacted to strong quarterly financial results. Revenue grew 29% and gross bookings, which measure the amount customers pay, went up 19%. On the whole, the company’s quarterly revenue and loss roughly matched Wall Street’s estimates, but signs of improvement in the business appeared to cheer investors. Shares rose 8% ahead of the open.

This afternoon, stay tuned for AMD, Clorox (CLX), and Ford. Semiconductor stocks, which had been flagging, rallied the last few days ahead of AMD’s quarterly report. A rally in shares of Intel (INTC) last week following its earnings helped the sector.

Apple is worth a deeper look, as the company is a bellwether for the global economy and its stock represents roughly 6% of the S&P 500’s® (SPX) market capitalization. Any surprises—good or bad—from AAPL could have ramifications for the broader market Thursday night into Friday.

Do your homework: Shares of Chegg (CHGG) plunged more than 45% this morning after the homework-help company reported that open AI tool ChatGPT is having a negative impact. “In the first part of the year, we saw no noticeable impact from ChatGPT on our new account growth and we were meeting expectations on new sign-ups,” the company said in a press release. “However, since March we saw a significant spike in student interest in ChatGPT. We now believe it’s having an impact on our new customer growth rate.”

Growth and value: Despite some rougher days recently, communication services and technology are still the best-performers this year—up 24.5% and 22%, respectively, through the end of April. These sectors are typically associated with the “growth” side of the market, but the growth-versus-value picture is less clear these days, note Schwab chief investment strategist Liz Ann Sonders and senior investment strategist Kevin Gordon in recent article in Schwab Insights & Education. Learn more about how the growth/value landscape has evolved and what it might mean for your investing.

Thinking cap

Ideas to mull as you trade or invest

Depth chart: Investors keep hearing about the stock market’s lack of “depth,” referring to how a handful of monster mega-cap stocks piled up gains recently while most stocks stagnated. There’s truth to that, but it doesn’t necessarily imply trouble ahead. For instance, a similar situation in late 2020 preceded a nice 2021 rally as many smaller stocks recovered from their pandemic losses during the economic reopening, says Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research. On the other hand, underperformance of the equal weight S&P 500® index (which weights all stocks equally instead of by market capitalization) in late 2021 preceded a much different set of circumstances in 2022—a full-blown bear market that dealt a large hit to the large-cap behemoths.

Oil leak: No one has a crystal ball, but WTI crude futures (/CL) price in flat to slightly lower crude over the next few months. This could reflect ideas of a slower U.S. economy ahead, but it certainly doesn’t build in any kind of deep recession scenario. Keep in mind that lower prices could tempt the U.S. government to replenish the Strategic Petroleum Reserve (SPR)—which would potentially put a floor under the market—and summer is peak driving season. U.S. inventories fell sharply last week, another potentially bullish signal. Except for that brief plunge to $65 in mid-March when banking fears gripped the economy, and the following brief rally to $83, /CL has spent most of its time since early December in the $70–$80 range. That seems to be where the front month contract has grown most comfortable over the last decade or so. It’s generally a level where prices aren’t too high for consumers and companies but where OPEC and oil companies can still make profits.

Home on range: Like crude, Two-year and 10-year Treasury note yields have settled into a trading range over the last month after those wild swings in March. The 2-year yield continues to pivot around 4%, while the 10-year keeps trading one side or another of 3.5%. The gap between them remains heavily inverted, though it’s narrowed since March. The inversion is likely to last until investors see signs of the Federal Reserve getting ready to slice interest rates, and no one really knows when that might happen. If you’re concerned about a possible credit crunch in the wake of this week’s failure of First Republic Bank (FRC), corporate bond yields remain the key element to track. As of last week, both high yield and investment grade corporate bond yields rose just slightly in April instead of rocketing up as you might expect if credit conditions were deteriorating quickly. Still, many analysts say banks are likely to grow more cautious after the FRC news, and the Fed’s continued emphasis on rate hikes could exacerbate credit market tightening.

Calendar

May 3: FOMC rate decision, April ISM Non-Manufacturing Index, and expected earnings from Bunge (BG), Estee Lauder (EL), Exelon (EXC), Kraft-Heinz (KHC), and Yum Brands (YUM).

May 4: Q1 Preliminary Productivity and expected earnings from Apple (AAPL), Anheuser-Busch (BUD), and PG&E (PCG).

May 5: April Nonfarm Payrolls, and expected earnings from Cigna (CI), Johnson Controls (JCI), Warner Bros. Discovery (WBD).

May 8: March Wholesale Inventories and expected earnings from Tyson Foods (TSN).

May 9: No major earnings or data expected.

May 10: April Consumer Price Index (CPI) and core CPI.

 

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

 

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