Powell Time: Fed Chairman's Tone Seen Key As Market Prices In High Chance Of Rate Hike

(Wednesday Market Open) Mystery lovers may be disappointed. Some of the drama has vanished ahead of today’s Federal Open Market Committee (FOMC) meeting.

Earlier this week, the market priced in a 60-40 probability of rates increases, which is unusually close to a coin toss and a situation unseen in several years considering the Federal Reserve typically telegraphs decisions far in advance. Now, with just hours until the announcement, the probability of a 25-basis-point hike stands at 89%, according to the CME FedWatch Tool.

Eye on the Fed

The possibility that last week’s banking turmoil could be in the rear-view mirror seemed to convince market participants that the Fed will follow the rate path it originally indicated weeks ago. Measures of volatility expectations, such as the Cboe Volatility Index (VIX), have pulled back from recent highs, suggesting markets have calmed somewhat. The S&P 500 index (SPX) finished yesterday above where it was when the banking troubles first hit two weeks ago.

That doesn’t mean there’s no excitement ahead of the decision at 2 p.m. ET or the press conference by Fed Chair Jerome Powell immediately after. With a 25-basis-point hike practically baked in, much of the attention will be on Powell’s remarks. The market is pricing in a sharp pivot for the second half of the year, building in the end of the Fed’s year-long tightening cycle.

• Does Powell steer the Fed policy path toward the market, or take a hawkish stance that defies Wall Street’s expectations? The difference could be important, but yesterday’s rally suggests market participants think Powell and company are coming around to the market’s point of view. There’s still a small chance the Fed might pause today, Schwab experts say, considering the potentially fragile state of the financial sector.
• If Powell projects the hawkishness people heard at his congressional testimony earlier this month, it’s likely to disappoint investors and pressure the market. On the other hand, this recent rally might have already built in dovish expectations, so if Powell sounds like he’s ready to pause, there might not be much immediate upside for stocks.
• Today’s Fed meeting isn’t just about the potential rate hike. It also includes new economic projections and an updated “dot plot” showing where the FOMC expects rates to go. Back in December when the Fed last issued projections, it put the terminal, or peak, rate between 5% and 5.25%. Now the futures market is putting high probabilities on this being the final rate hike of the cycle.
• If the Fed hikes 25 basis points today and then stops, it would mean a terminal rate between 4.75% and 5%. Still, expect Powell to promise that the Fed’s fight against inflation continues, and to prepare investors for at least a possibility of future rate increases if inflation persists. The Fed has spent months building its inflation-fighting case, so it’s not likely to drop that anytime soon, barring some unprecedented economic trouble. That means Powell could still sound hawkish even if he hints at a possible pause.

For those trading today, keep in mind that everything remains fluid. Consider smaller trading sizes if you’re concerned about recent volatility. The market has swung rapidly back and forth during and after recent Powell press conferences.

Morning rush

• The 10-year Treasury note yield (TNX) rose 3 basis points to 3.64%.
• The U.S. Dollar Index ($DXY) was slightly lower at 103.1.
• The Cboe Volatility Index® (VIX) futures sank to 21.58.
• WTI Crude Oil (/CL) fell slightly to $69.38 per barrel.

Though yields rebounded yesterday after cratering last week, the Treasury market remains incredibly volatile. Yesterday was the ninth straight day of 10-basis-point changes in the 2-year Treasury yield. Don’t be surprised if this volatility continues until investors feel the banking crisis is under control.

Just In

Today’s economic data from the U.K. underscore the complexities confronting global central banks. Inflation unexpectedly accelerated in February, surpassing all economists’ forecasts on the eve of an interest rate decision by the Bank of England (BOE).  

What to Watch

New Home Sales for February are expected Thursday soon after the open, with consensus for a 4.5% drop from January to a seasonally adjusted 640,000, according to Trading Economics. This comes after a surprising 14.5% monthly surge in February Existing Home Sales reported yesterday.

Though monthly sales jumped, it’s important to understand that on an annual basis, sales fell 22%. That may be a sign of rising rates and prices, though prices fell in February for the first time in 11 years, by 0.2% to $363,000. That broke a 131-month streak of rising prices for existing homes and suggests hesitation by some potential buyers to purchase homes at what they see as the top of the market, according to research firm Briefing.com.

Also ahead Thursday are weekly initial jobless claims data,. This week featured another tech sector layoff announcement courtesy of Amazon (AMZN), but tech layoffs haven’t really shown up in claims data so far this year. Analysts expect new claims of 197,000, according to Trading Economics. Anything above 200,000 might be viewed as slightly positive, perhaps a sign of the job market tightening and pushing down inflation.

Stocks in Spotlight

Nike (NKE) shares fell in premarket trading despite the athletics company beating Wall Street analysts’ earnings and revenue projections.

KB Home (KBH) reports after the close today, one day before investors get a look at February New Home Sales. In its Q4 earnings report back in January, KBH reported a 16% rise in revenue to $1.94 billion, but focus was on a steep drop in net orders. It’ll be interesting to see whether that category improved somewhat in Q1.

More earnings are on tap tomorrow from Accenture (ACN), Darden Restaurants (DRI), and General Mills (GIS). Keep an eye on DRI, as casual dining sometime feels the icy fingers of recession earlier than some other business sectors.

Market minutes

Here’s how the major indexes performed Tuesday:

• The Dow Jones Industrial Average® ($DJI) rose 316 points, or 0.98%, to 32,560.
• The Nasdaq 100® (NDX) climbed 1.42% to 12,741.
• The Russell 2000®(RUT) rose 1.88% to 1,777.
• The S&P 500® index (SPX) rose 51 points, or 1.3%, to 4,002, its first close above 4,000 since March 6.

U.S. stocks climbed a second straight day Tuesday, with the Nasdaq ($COMP) ending near a five-week high as jitters over bank instability eased and market expectations coalesced around a 25-basis-point interest rate hike.

Regional banks and other financial companies accounted for much of the market’s upside leadership, fueled by a Wall Street Journal report that JP Morgan Chase (JPM) CEO Jamie Dimon is leading discussions to stabilize First Republic Bank (FRC), boosting the latter’s shares about 45%.

Energy companies also performed strongly Wednesday as crude oil prices rebounded from a recent slump. Consumer discretionary and communications services stocks rose, too. Consumer staples and real estate were among the weaker sectors. Treasury yields jumped, with the 2-year note rising back above 4%.

Talking Technicals: The SPX is caught in a bit of a no-man’s land breaking out of last year’s downtrend yet breaking below this year’s uptrend as we go into the Fed’s interest rate decision (see chart below). While bulls and bears may argue for uptrends or downtrends, there is a third option—sideways. Since the Fed is trying to walk the line between attacking inflation and avoiding another credit crisis, a “wait and see” attitude may be the path of least resistance here.  

CHART OF THE DAY: CAUGHT IN BETWEEN: The S&P 500 (candlesticks) appears to be caught in between last year’s downtrend and this year’s uptrend. We’ll see if the Fed’s decision and projections have any impact on the market’s path forward. Data source: S&P Dow Jones Indices, 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 invest

1+1=? Recession talk gained steam with the latest banking troubles, but history shows downturns don’t necessarily follow every financial crisis. Over the last 50 years, there have been only 14 financial crises in the U.S., including the one this year associated with the failures of Signature Bank (SBNY) and SVB Financial (SVIB). Recessions followed seven of the previous 12 financial crises going back to 1974, Schwab data shows. Several of those preceded the Great Recession of 2008–09, a unique period. People may not remember bank failures in 1998, 1994, and 1984, but none of them were followed by recessions. Whatever happens this time, it’s clear that the lightning-fast news flows of social media, along with depositors’ ability to move money at the touch of a button, can cause failures to happen today far more quickly than in the past, say Schwab Chief Investment Strategist Liz Ann Sonders and Senior Investment Strategist Kevin Gordon. Still, they emphasize that this is not a replay of 2008 . “Today’s largest banks are well-capitalized and are already benefiting from deposit flight from the weaker banks,” they write. “In addition, our country’s capital-markets-based financial system is not intricately linked with its regional banks.”

Extra credit: Another recession barometer is credit spreads. A credit spread is the difference between the yield on a Treasury note and another security (debt) with similar maturity date but of lesser credit quality. A widening spread—when yields on “riskier” corporate bonds gain versus yields on government debt—can reflect investors migrating toward perceived “safety,” though no investment is truly safe. Investors flocking to higher-quality corporate debt and government Treasuries can push yields down on those, as we saw last week, and raise yields on debt from companies considered riskier. Investors demand a higher yield as compensation for taking on the additional credit risk. Recently, spreads widened between investment-grade and high-yield corporate bonds, though that narrowed a bit earlier this week. Banking turmoil drives some of this, partly on concerns that smaller, less established companies may face a credit crunch as banks tighten lending standards.

GDP ramifications: A tighter credit picture could mean higher borrowing costs for companies deemed to have higher default risk, and perhaps slower economic growth if many companies can’t obtain credit at costs they consider reasonable. Some analysts note that demand for credit has fallen in recent weeks, which may be a sign that the widening spread is already having an impact. Keep an eye on the Atlanta Fed’s GDPNow tool, which on March 16 indicated Gross Domestic Product (GDP) growth of 3.2% in Q1. Will that come down when it updates on Friday? And what will the FOMC projections for full-year 2023 growth look like today? The credit market could factor into calculations.

Calendar

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).

March 29: February Pending Home Sales.

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

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