Hopes For Return To Banking Stability Drive Market's Anticipation For A Fed Rate Hike

(Tuesday Market Open) As banking uncertainty eased and stock index futures built on yesterday’s gains, expectations solidified for a 25-basis-point interest rate hike by the Federal Reserve. The probability of that increase hit 85% this morning, according to the CME FedWatch Tool, up from 60% as recently as early Monday.

A Wall Street Journal report that JP Morgan Chase (JPM) CEO Jamie Dimon is leading discussions to stabilize First Republic Bank (FRC) appeared to lend support to the stock market early Tuesday, and the banking sector—including FRC—rallied in premarket trading.

At the same time, fixed income continued its retreat and volatility gave back about half the gains of the last 12 days. The dollar is also lower, while crude oil rallied. All this suggests concern and uncertainty are easing, and helps reinforce expectations that the Fed might hike rates.

However, with the Federal Open Market Committee (FOMC) meeting beginning today and a decision tomorrow, it’s unclear how much traction this rally can gain. Investors might want to remember that stocks have often climbed ahead of recent Fed meetings, only to sink as participants digested post-meeting remarks from Fed Chairman Jerome Powell.

For those trading today, keep in mind that everything remains fluid and is subject to change as new information pours in. Consider smaller trading sizes if you’re concerned about recent volatility.

Morning rush

• The 10-year Treasury note yield (TNX) rose 8 basis points to 3.56%.
• The U.S. Dollar Index ($DXY) recently traded lower at 103.18.
• The Cboe Volatility Index® (VIX) futures declined to 22.7 after reaching nearly 29 at one point Monday.
• WTI Crude Oil (/CL) climbed to $68.83 per barrel, up sharply from recent lows under $65.

Stocks took their cues Monday from volatility, to some extent. The VIX fell below 25 by midday, and that could continue being a psychological level to watch. Treasury yields also ticked higher, which—after last week’s cratering—could be seen as positive for stocks. That may sound counterintuitive, since climbing yields typically hurt equities, but when there’s uncertainty, falling yields can reflect investors fleeing stocks for the perceived “safety” of fixed income. That lack of confidence isn’t a bullish vote of confidence in Wall Street.

Eye on the Fed

Over the last week, it feels like just about every pundit and newspaper editorial board has made arguments for or against a rate increase. Now it’s up to the voters, so to speak.

The outcome of the FOMC meeting goes far beyond the question of to hike or not to hike. There’s also the FOMC’s updated economic and rate projections, and the tone Fed Chairman Jerome Powell takes at the post-meeting press conference tomorrow afternoon.

Some analysts believe he’ll borrow a page from the European Central Bank’s (ECB) playbook, as the ECB raised rates last week. At the time, ECB President Christine Lagarde said that the central bank was standing strong against inflation but prepared to step in to supply liquidity amid banking sector turmoil.

Chances of rates being at the current 4.5% to 4.75% or higher by December are now around 25%, according to the FedWatch Tool, meaning the market has built in 75% chances of a rate cut at some point this year. Will the Fed’s dot plot tomorrow and its terminal, or peak, forecast, back up these projections? The 2-year Treasury yield fell below fed funds futures last week, something that historically has indicated the end of Fed tightening cycles.

What to Watch

Real estate comes into focus 30 minutes after the opening bell today with February Existing Home Sales figures. It follows better-than-expected Housing Starts and Building Permits last week and comes ahead of February New Home sales due Thursday.

Mortgage rates began to fall last week, though that won’t be picked up in February’s home sales data. In fact, rates spent much of February on the climb, reaching 7% for the 30-year mortgage at one point. Rising rates could factor into home sales, though maybe not directly as a barrier to growth. Instead, it might be reflected in a higher proportion of homes being sold through cash sales, or in falling home purchases by first-time buyers, who tend to be more sensitive to rising borrowing costs.

Existing home sales are expected to rise 0.5% month-over-month in February to a seasonally adjusted 4.1 million, according to Trading Economics. New home sales for February are expected Thursday, and consensus is for a 4.5% drop from January, when sales soared.

Stay tuned Wednesday afternoon for more perspective on the housing market when home builder KB Home (KBH) is expected to report earnings.

Stocks in Spotlight

Cue the running metaphors ahead of Nike’s (NKE) earnings, expected after the close today. NKE looks to press the pace after its previous healthy quarter, and analysts see revenue of $11.4 billion and earnings per share of $0.51, according to Earnings Whispers.

NKE’s large presence in China can make it a helpful barometer of that country’s reopening. Barron’s reported over the weekend that sportswear demand has surged in China recently and is expected to grow by double-digits this year—perhaps good news for the company with a swoosh.

Share prices rose in December following a NKE revenue beat, and analysts then noted progress in clearing out bloated inventories. Check for updates on that front, and also look for the status of NKE’s gross margin. Inventory issues leading to markdowns have been a challenge.

Remember, NKE can have an impact on other apparel- and athletic-wear makers. Stocks like Lululemon (LULU), Under Armour (UAA), and Foot Locker (FL) often rise or fall in sympathy when NKE reports.

More earnings are on tap later this week from Accenture (ACN), KB Home (KBH), Darden Restaurants (DRI), and General Mills (GIS).

Market minutes

Here’s how the major indexes performed Monday:

• The Dow Jones Industrial Average® ($DJI) climbed 382 points, or 1.2%, to 32,244.
• The Nasdaq 100® (NDX) rose 0.34% to 12,562.
• The Russell 2000®(RUT) rose 1.25% to 1,747.
• The S&P 500® index (SPX) climbed 35 points, or 0.89%, to 3,951, back above its 200-day moving average of 3,936.

It was back to the future for major stock indexes Monday, as sectors like financials, small-caps, and energy that got hammered last week jumped to the top of the leader board amid more assurances from the Fed that the U.S. financial system is resilient.

Meanwhile, last week’s trend setters—info tech and communication services—spent part of Monday in the red before finishing with modest gains. Heavier-than-normal volume at the New York Stock Exchange (NYSE) Monday might have indicated decent conviction behind the rally. Still, spillover buying may be hard to come by while the FOMC decision looms.

• In one sense, the 180-degree turn suggests some investors think things got overdone to the downside on some stocks and to the upside on others. Signs of stability in the banking sector over the weekend, along with the forced takeover of Credit Suisse by UBS brokered by Swiss regulators, appeared to ease some of the fears that led many to pile into Treasury bonds, the U.S. dollar, and mega-caps.
• That arguably set the stage for Monday’s turnaround but doesn’t undo what’s been a major sector rotation over the last month favoring “risk-on” parts of the market like tech and communication services. Those two sectors are both up double-digits so far in March.
• Treasury yields rebounded a bit Monday, not necessarily on anything Fed-related but more in a recovery from last week’s dive. The 10-year Treasury note yield (TNX) managed to stay above support levels seen between 3.35% and 3.4%, and the premium of the 2-year Treasury note yield to the TNX is now near 50 basis points—a dramatic step back from the 42-year high above 100 posted less than two weeks ago. We haven’t seen this sort of volatility in fixed income since 1987, and it speaks to the potential for continued volatility in stocks.

Quick take: Don’t forget to check Schwab’s Weekly Market Outlook for Chief Global Investment Strategist Jeffrey Kleintop’s 90-second take on the markets for the week ahead.

Talking Technicals: Gold swung back to peaks it visited early last year, rallying above $2,000 an ounce Monday. It was the first time at that lofty level since an intraday move last April 18. Incidentally, the last time gold was above $2,000, the U.S. fed funds rate was around 0.25%, and now it’s above 4.5%. Higher rates typically keep gold down, which is exactly what we saw most of last year. If the rally continues, the 2022 high of $2,078 is a possible resistance area, not far below the 2020 peak of $2,089.

CHART OF THE DAY: GOLD STAR. Gold futures (/GC-candlesticks) popped above $2,000 an ounce intraday Monday for the first time since last April before falling just below it by late in the day. That’s well above the 200-day moving average (blue line), which gold pushed past earlier this year even before ideas that the Fed might pause. Data source: CME Group. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or investStorm shelter leak: Investors piled into info tech stocks recently due to banking industry fears, but by some measures the tech sector might not provide an umbrella. The recent instability in financials could have a negative fundamental impact on tech, one analyst told CNBC Monday, in part because financial companies tend to be massive buyers of tech products. Drilling down to one aspect—cloud computing—many financial firms were intending to shift their workloads into the public cloud over the next five years, according to a 2022 report by management consulting firm McKinsey & Co. It’s unclear how or whether recent pressures on the banking industry could affect those plans, or what that might mean for cloud-driven companies like Amazon (AMZN), Microsoft (MSFT), and Alphabet (GOOGL). Which points up another reason why tech is considered a “risk-on” sector: its dependence on spending decisions by other companies.

Cloud cuts: Speaking of tech, AMZN announced 9,000 additional layoffs on Monday, adding to the drumbeat of tech companies cutting jobs. Notable this time is where some of the job cuts occur—AMZN’s Amazon Web Services (AWS), its cloud division and the primary engine of recent growth. As some analysts pointed out, AWS hit the “law of large numbers” over the last few years, unable to continue the better than 40% annual growth it once posted. Some analysts expect AWS growth to slow to the high teens this year, though it remains the leading cloud business, ahead of MSFT and GOOGL. While it’s easy to say AMZN’s cuts simply reflect internal issues as the company deals with low margins, it also could speak to continued slowing in cloud demand. MSFT offered  a conservative cloud outlook the last time it reported, and also saw sequential slowing in that business. As noted above, the financial turmoil and recession worries could have an impact on cloud spending, raising questions for cloud companies in general. Earnings reports next month could help lift the haze.

Hike and pause? One idea you don’t see touted as much but could possibly be an option would be for the Fed to raise rates but pause its quantitative tightening (QT) program. The Fed instituted QT last year to shrink its swollen balance sheet by about $95 billion a month. The impact, over time, is thought to be similar to that of rate hikes, though its ultimate effect is still “uncertain,” Fed Chairman Jerome Powell said last year. One supposed benefit of QT is to allow the Fed to “reload for the next crisis,” the Federal Reserve Bank of Richmond noted last year in a research piece. For that reason, the Fed might be hesitant to pause QT. But whether it’s a pause in hikes or QT, either action potentially sends a signal that the Fed is worried about structural issues more than inflation, which might not soothe investors. 

Calendar

March 22: FOMC rate decision.

March 23: February New Home Sales and expected earnings from Accenture (ACN), General Mills (GIS), and Darden Restaurants (DRI).

March 24: February Durable Goods Orders.

March 27: Expected earnings from Carnival Corp. (CCL).

March 28: March Consumer Confidence and expected earnings from McCormick (MKC) and Walgreens Boots Alliance (WBA).

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

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