Markets Stumble as Fed Signals a Tougher Year Ahead for Inflation, Jobs

(Thursday Market Open) The bleeding continues.

In a nutshell, the Federal Reserve’s message yesterday to investors is to expect higher rates for longer amid a worsening economy and growing inflation. For Wall Street, that combination could be kryptonite.

Bullish investors may be coming to dread Federal Reserve meetings, considering the market’s response to the last two. Stock index futures fell about 1% early Thursday, building on losses of 0.5% suffered late yesterday following the rate hike announcement and Fed Chairman Jerome Powell’s remarks to media.

Surprisingly, the Fed’s hawkish stance hasn’t changed things on the ground too much this morning, other than the obvious decline in major index futures. Treasuries, the U.S. dollar, and volatility all look relatively tame so far.

Adding to investors’ misery, both the Bank of England (BoE) and the European Central Bank (ECB) followed up today with rate hikes and forecasts of their own for weaker economic growth. It’s not surprising to see the market wobble after that one-two punch by central banks yesterday and this morning.

Looking for technical support? It could be near 3,970 in the S&P 500® index (SPX). Below that is that band between 3,920 and 3,940 we’ve mentioned. The SPX tested 4,100 resistance twice in recent weeks and got shoved back lower almost immediately both times. That seems like a pretty firm barrier, and failure to climb past it keeps the market in a technical downtrend.

Morning Rush

• The 10-year Treasury yield (TNX) is down 1 basis point at 3.48%.
• The U.S. Dollar Index ($DXY) is up 0.5% at 104.27.
• Cboe Volatility Index® (VIX) futures are near 21.3.
• WTI Crude Oil (/CL) is up marginally at $77.34.

Just In

November Retail sales took a dive, falling 0.6%. Stripping out automobile sales, they still fell 0.2%.

Analysts had expected a headline of -0.3% and a non-auto figure of 0.3%. Both were down sharply from larger than 1% growth in October.

It’s a single data point, so there’s no way to take much away from it except it appears consumers tightened their wallets in November just as holiday shopping season got into swing. That’s not necessarily good news for the retail industry.

Initial unemployment claims stayed extremely low at 211,000 last week, the government reported early Thursday, down from a revised 231,000 the week before. Continued claims of 1.67 million were steady with the prior week.

This kind of report reinforces Powell’s observations yesterday about the tenacity of the labor market.

FOMC Capsule

The Federal Open Market Committee’s (FOMC) hike of 50 basis points to a range between 4.25% and 4.5% met Wall Street expectations. It was “the rest of the story,” as a famous radio host once said, that did the damage.

The market took a while to digest all the different puzzle pieces the Fed put in motion yesterday. When the smoke cleared, it saw an ominous mixture of higher future rates, stubborn inflation, and lower growth. Some FOMC members even projected economic growth to fall, which we hadn’t seen before.

Nothing we got yesterday really pleased the market. Investors had hoped the Fed would begin to moderate next year. Instead, the central bank actually raised the terminal, or peak, rate. The Fed’s economic projections didn’t show any sunlight, either.

The central bank and Powell showed no sign of a “pivot” to lower rates in the near future; instead, they delivered a firm message that rates aren’t nearly high enough yet to tame inflation, need to go higher, and perhaps stay there longer. Rates above 5% by the end of next year are now penciled in by the FOMC, with no hints of rates coming down until 2024.

The FOMC now sees a terminal rate of between 5% and 5.25% by the end of next year, up about 50 basis points from the previous terminal projection in September. This reflects ideas that overheating—particularly in the services part of the economy—continues to push prices higher. Specifically, the Fed has its eyes on wages and housing.

The Fed won’t consider rate cuts until it’s convinced inflation is “coming down in a meaningful way,” Powell said. He sounded hawkish pretty much throughout his remarks, especially when he said rates aren’t yet restrictive despite rising 425 basis points in just eight months. That’s been a rate climb unlike any seen in decades.

Market Leans Toward Smaller Hikes Next Year

The one thing that might’ve given the market a bit of support is what Powell said about the pace of hikes from here. The question, he said, is less about how quickly the Fed raises rates and more about finding the right level that puts inflation on a sustainable downward path.

Powell made it very clear the current rates, even with today’s hike, aren’t close to that level yet.

• But if the Fed takes more time getting rates up to that 5% to 5.25% level, that would potentially leave it room to raise rates just 25 basis points at its next two meetings in February and March. Keep an eye on the CME FedWatch tool in coming days to see what the futures market indicates about expectations for those two meetings.
• As of this morning, the FedWatch tool puts odds at 71% of just a 25-basis-point rate increase at the FOMC’s February 1 meeting to a range between 4.5% and 4.75%. There are 29% odds of a 50-basis-point increase.
• For the March 22 meeting, odds are 56% of another 25-basis-point hike. But it’s still very early and the Fed is going to see a lot of data between now and then.
• Even if it raises rates more slowly toward the expected terminal level, the Fed seems to be leaning toward keeping rates higher for longer. As late as the end of 2024, most FOMC members surveyed in the Fed’s dot-plot see rates hanging out between 4% and 5%. A majority of FOMC members don’t see rates getting back below 4% until the end of 2025.

It’s going to be tougher for corporations in this kind of a rate environment. Weaker economic growth forecasts and higher inflation projections raise questions about the path of corporate earnings, with many analysts already saying the 5% earnings growth expected by Wall Street for 2023 may be overdone. This could weigh on the market.

We aren’t likely to see earnings estimates start coming down over the next two weeks simply due to the holidays. But when everyone gets back in January, that could be the theme. If earnings projections begin falling, that might force investors to take another look at the stock market’s current levels to see if they reflect the reality of possible weaker corporate growth.

Reviewing the Market Minutes

The market gyrated after the Fed’s 50-basis-point rate hike and economic projections, finishing lower Wednesday. As investors eyeballed the central bank’s dot-plot of future rate projections, the picture seemed dimmer for Wall Street.

Here’s how the major indexes performed Wednesday:

• The Dow Jones Industrial Average® ($DJI) dropped 142 points, or 0.42%, to 33,965.
• The Nasdaq® ($COMP) dropped 0.76% to 11,171.
• The Russell 2000® (RUT) dropped 0.7% to 1,819.
• The SPX fell 24 points, or 0.6%, to 3,995.

Talking Technicals: If you’re a regular reader of the Daily Market Update, first thank you. Second, maybe you’ll recall our discussion a week or two ago about near-term technical support for the 10-year Treasury yield (TNX). Interestingly, the trend line of lower highs since mid-October is converging with both the current level of TNX and its 100-day moving average, or MA (see chart below). That makes this level pivotal for the 10-year yield, so the direction it goes from here should be watched closely.

CHART OF THE DAY: SUPPORT CONVERGING. The 10-Year Treasury yield (TNX—candlesticks) now sits near a downtrend line on the chart (red line) and near its 100-day MA (blue line). We’ll see where it goes now that the FOMC has spoken. Data source: Cboe. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

Will ’23 Salary Projections Cool Too? Inflation thermostats may be set to “cool” this week, but so far, nobody’s told payroll managers to put on their sweaters. A recent employer survey from Willis Towers Watson (WTW) shows U.S. employers are set to boost salaries an average of 4.6% in 2023, up from this year’s average of 4.2%. WTW said the upward pressure on salaries isn’t just about recent high inflation—it’s also about continuing high employee expectations despite expanding headlines about industry-specific layoffs and job cuts. WTW added that whatever’s going on in the general economy, employers remain worried about retaining talent—75% of respondents said they’re still having problems attracting and hiring the right workers. That’s a level three times higher than WTW measured in 2020.

No Fed White Flag Yet: By raising rates just 50 basis points yesterday instead of 75 (as it did the prior four meetings), the FOMC seemed to acknowledge that the impact of rate hikes can spread slowly across the economy. By hiking less now and perhaps in the future, the Fed can give its earlier, higher rate decisions proper time to take effect. After eight months of tighter money, parts of the economy like housing and gas prices have fallen, and inflation in general is growing less swiftly. What hasn’t cooled off is employment, and that might be what the Fed is waiting to see. There have been layoffs across the tech industry and now also in banking, but not to the extent where U.S. jobs growth slowed or jobless claims ticked higher. Many economists worry the Fed has overshot with rate hikes, and that a recession could be in the cards.

Let’s Eat Out: Earnings reports can be thin and far between this time of year just as waistlines tend to thicken from holiday feasts. If dining out is part of your yuletide plans, keep an eye on Darden Restaurants (DRI), scheduled to report Friday before the open and one of the few companies on the calendar this week. The operator of Olive Garden and Longhorn Steakhouse got an upgrade Wednesday from Wedbush, but DRI had a tough time earlier in 2022. Same-store sales growth of 4.2% missed Wall Street’s consensus estimate of 5.1% during the quarter that ended August 28, hurt by disappointing Olive Garden performance. The company got slammed then by a big rise in commodity prices and also saw margins pressured by sharp wage growth. Though inflation was a headwind for the company’s customers last summer, it has slowed the last two months, perhaps providing a tailwind. That could be playing into its performance of shares, up 14% so far in Q4. Customers of DRI’s restaurants typically make $50,000 or less per year, so it’s a good barometer of how middle- to lower-income people choose to spend.

Notable Calendar Items

Dec. 16: Expected earnings from Accenture (ACN) and Darden (DRI)

Dec. 19: No earnings or data of note

Dec. 20: November Housing Starts and Building Permits and expected earnings from General Mills (GIS) and Nike (NKE)

Dec. 21: November Existing Home Sales and expected earnings from Rite Aid (RAD) and Micron (MU)

Dec. 22: Government’s final Q3 GDP estimate and expected earnings from CarMax (KMX)

Dec. 23: November Durable Orders, November Personal Income and Spending, November PCE Prices, November New Home Sales, and Final December University of Michigan Consumer Sentiment

Dec. 26: Markets are closed on Christmas day. Have a great holiday!

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

Image sourced from Shutterstock

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