Markets Firmer Overnight Amid Optimism Debt Ceiling Deal May Happen

(Monday market open) Heightened hopes that the U.S. will avoid a debt ceiling debacle appear to have put a floor under the market, with stocks poised to start the week on a firmer note as investors await key earnings reports from several major retailers.

Stock index futures based on the S&P 500® and Dow Jones Industrials Average rose overnight after the Wall Street Journal reported Saturday that the Biden administration and congressional Republicans are making progress in negotiations over federal spending and raising the debt limit. Treasury Secretary Janet Yellen said she’s “hopeful” the talks could result in an agreement, the newspaper reported.

A debt ceiling agreement would remove some uncertainty as the market shifts into the tail end of earnings season, with Federal Reserve policy and recession prospects still front-and-center topics. A larger-than-expected drop in a New York state manufacturing index fueled recession concerns, but don’t expect the Fed to make any significant moves away from its inflation battle, based on fresh comments from the central bank’s Atlanta leader.

Morning rush

• The 10-year Treasury note yield (TNX) was up about 3 basis points at 3.489%

• The U.S. Dollar Index ($DXY) fell slightly to 102.475

• The Cboe Volatility Index® (VIX) rose 0.39 to 17.42

• WTI Crude Oil (/CL) was up 48 cents at $70.52.

Treasury bills remain volatile as the debt ceiling issue remains unresolved. ″Treasury bills maturing before that June 1 “X” date are trading at premium, with bills maturing later this month offering yields below 4% as investors pay up for more certainty that they’ll be repaid on time,” notes Collin Martin, director, fixed income strategy, at the Schwab Center for Financial Research. “Meanwhile, bills maturing on June 1 and in the days that follow offer higher yields as investors demand more compensation for the risk that they aren’t repaid on the scheduled maturity date.”

Just In

Atlanta Federal Reserve President Raphael Bostic doesn’t expect any interest rate cuts at least through 2023, even if the economy slips into recession. “For me, inflation is job No. 1. We’ve got to get back to our target,” Bostic told CNBC’s Steve Liesman during an interview this morning. “If there’s going to be some cost to that, we’ve got to be willing to do that.” Bostic’s remarks appear to punch holes in ideas the Fed could lower rates as soon as July, based on the CME FedWatch Tool.

The Empire State Manufacturing Index, a measure of business conditions in New York state, dropped to -31.8 from 10.8 previously, well below expectations for a decline to just -3.7.

Stocks in the Spotlight

Cash registers ring: Retail companies crowd the earnings calendar this week, kicking off tomorrow morning with Home Depot (HD). That’s expected to be followed by Target (TGT) and Walmart (WMT) on Wednesday and Thursday mornings, respectively. Foot Locker (FL) wraps things up Friday, with more major retailers ahead next week.

Most big-box stores wrestled with rising prices in late 2022. Many shared conservative guidance early this year, and executives expressed concerns about consumer sentiment in these high-rate, high inflation times.

A critical element to watch is what the companies say about discretionary spending, versus staples. Are people still tightly clutching the Charmin, so to speak, or are they making more “fun” purchases? That could tell us a lot about whether recession looms, as consumer spending makes up about 70% of the economy. A recent rise in initial jobless claims suggests consumers may remain reticent, but we’ll see what the big boxes have to say.

Digging the foundation: With HD up first, it’s worth noting that last week, Baird lowered the firm’s price target on HD. Channel checks point to another lackluster start for outdoor seasonal categories, the analyst tells investors in a research note. However, Baird believes seasonal sales in May “are off to a hot start.”

Last time out, HD projected flat sales and comparable sales growth for fiscal 2023, and also forecast a diluted EPS decline in the mid-single digits. Check closely when HD reports to see if the company makes any changes to that relatively gloomy outlook.

Exceeding expectations: As of Friday, 92% of the companies in the S&P 500® have reported earnings for Q1. Of these companies, 78% have reported actual EPS above the mean EPS estimate, which is above the 10-year average of 73%, according to research firm FactSet. It’s also the highest percentage of S&P 500 companies reporting a positive EPS surprise since Q3 2021.

Eye on the Fed 

The probability of a June rate pause stands at 83%, according to the CME FedWatch Tool.

Friday’s preliminary May University of Michigan Consumer Sentiment report sent mixed signals on inflation. Year-ahead inflation expectations pulled back to 4.5% after rising to 4.6% in April. However, the five-year outlook increased to 3.2%, the highest since 2011, compared to 3% last month. The Fed has made it clear how important it is to keep inflation expectations “anchored,” and last year when the survey showed a big jump in five-year expectations the Fed quickly increased the pace of rate hikes.

That said, we’re in a different place now. Inflation has receded quite a bit since then, and data hint at a slowing economy. This was one report and the Fed reviews a vast swath of data. The one-year expectations decrease was also encouraging.

Perhaps with that in mind, the market still expects rate cuts this year.The fed funds market suggests a rate cut as soon as the fall, with three cuts being priced in by the end of the year. However, Fed officials keep pushing back with pledges to hike rates again if necessary to tame inflation. At this point, with the fed funds rate above the annual inflation rate, the Fed arguably might start feeling a bit less pressure to push rates higher. That doesn’t mean it will slice rates, despite market hopes, especially with unemployment so low.

What to Watch

Sales call: Along with HD earnings, tomorrow brings April Retail Sales data before the opening bell. Retail sales were on the light side in March, but that partly reflected low energy prices that kept gasoline sales down (the report isn’t adjusted for inflation). The updated consensus for April is a 0.6% rise sequentially in overall retail sales and a 0.3% bump in retail sales excluding automobiles, says Trading Economics.

If numbers are softer than expected, it could intensify ideas that a recession is brewing, Consumer spending forms about 70% of the U.S. economy, so if people sense their wallets getting lighter, that can show up in Retail Sales data.

And Friday’s Consumer Sentiment survey didn’t exactly inspire confidence, falling sharply to a six-month low of 57.7 from 63.5 in April, well below forecasts of 63. “Consumers’ worries about the economy escalated in May alongside the proliferation of negative news about the economy, including the debt crisis standoff,” said Surveys of Consumers Director Joanne Hsu. However, that was May data, not April, so it may not have an impact on the April sales figure.

Thinking cap

Ideas to mull as you trade or invest

DJIA evolution? It’s been about three years since owners of the venerable Dow Jones Industrial Average ($DJI) last shifted its components, and there’s no hint that S&P Global, which owns and runs the $DJI, has plans for more changes. If it does shuffle the cards, industrial conglomerate 3M (MMM) conceivably could lose its place on the covered list of 30 $DJI stocks after more than 45 years, suggests the Star Tribune, MMM’s hometown newspaper in Minnesota. “That position of prestige could be in jeopardy,” the paper said in a recent article. Here are some reasons the Star Tribune cites: MMM is spinning off its health care division at the end of 2023, which composes a quarter of the company’s annual $34 billion in revenue. MMM now ranks among the smallest members of the $DJI by market capitalization at 27th and is 26th by revenue even before it sheds the health care business. MMM shares are down 35% in the last five years, the worst performance among the $DJI’s members. MMM got added to the $DJI in 1976, meaning only Procter & Gamble (PG) has a longer tenure.

More labor pains: The April jobs report may seem like old news, but there’s still stuff to glean more than a week later. The data had its bright spots, like prime-age labor force participation hitting its highest level since 2008 and unemployment posting a 50-year low of 3.4%. Otherwise, it’s arguable that the report didn’t live up to the hype. “The labor market has become a contentious issue for the market bulls and bears given its current strength, but investors need to be careful when someone rests their bull case on saying the labor market is resilient (due to something like a low unemployment rate),” says Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research. “The labor market is always at its strongest right before a recession hits; and in fact, the average increase in the unemployment rate from its cycle trough to the start of a recession is just 0.3%. It’s not an increase in unemployment that causes a recession; it’s a recession that causes an increase in unemployment.”

Amid bank turmoil, private eyes watching: The U.S. banking turmoil that’s claimed three regional lenders since March continues to reverberate throughout the financial system in ways both high-profile and under the radar. In an example of the latter category, opportunities for private credit may be expanding even amid financial market uncertainty, according to Goldman Sachs Asset Management (GSAM). Higher quality borrowers that may otherwise have issued debt in the public markets are seeking financing in private markets, attracted by greater certainty and speed of completing transactions, Goldman’s Stephanie Rader and James Gelfer write in a report. As interest rates climb, these loans are pricing at wider spreads (relative to similar-maturity high-yield bonds or leveraged loans) and higher overall yields, and they have more conservative capital structures. While Rader and Gelfer expect rising default rates the next few years, they expect private debt to outperform public credit as more borrowers struggle to repay obligations. And while, the outlook for defaults in private credit may be more opaque than in high yield or leveraged loans, the category has a number of strengths.

Calendar

May 16: April Retail Sales and expected earnings from Home Depot (HD).

May 17: April Housing Starts and Building Permits, and expected earnings from Target (TGT).

May 18: April Existing Home Sales and Leading Economic Indicators, and expected earnings from Walmart (WMT).

May 19: Expected earnings from Deere (DE) and Foot Locker (FL).

May 22: No major earnings or data expected.

May 23: April New Home Sales and expected earnings from AutoZone (AZO), and Dick’s Sporting Goods (DKS).

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

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