Fed Verdict Awaited: Fresh Signs Of Easing Inflation Reinforce Rate Hike Pause Expectations

(Wednesday market open) For the first time in well over a year, the Federal Open Market Committee (FOMC) is widely expected to end its meeting today without raising interest rates. Stocks entered a new bull market last week and traded at nearly 14-month highs yesterday after new economic data showed that inflation was easing.

Additional fresh data early Wednesday reinforced ideas that inflation is becoming a secondary issue for the markets. The May Producer Price Index (PPI) fell -0.3%, compared with the average analyst estimate for a 0.1% decline.

If the FOMC does pause hikes today, it may not mean the end of its 14-month rate increase cycle. Futures trading builds in moderately high chances of another 25-basis-point hike in late July. Also, the Federal Reserve isn’t expected to lower rates anytime soon from their current 16-year highs, which could keep the brakes on economic and earnings growth. The Fed decision is due at 2 p.m. ET, followed soon after by Fed Chairman Jerome Powell’s press conference.

The S&P 500® Index (SPX) posted its highest close since April 2022 yesterday, but, perhaps more importantly, there are signs of the rally broadening beyond the largest stocks. The small-cap Russell 2000 Index (RUT) rose more than 1% Tuesday to its highest level since early March. Regional banks and oilfield services stocks led the gainers on Tuesday.

Morning rush

• The 10-year Treasury note yield (TNX) fell 2 basis points to 3.81%.
• The U.S. Dollar Index ($DXY) edged lower to 103.11.
• The Cboe Volatility Index® (VIX) futures are steady at 14.6.
• WTI Crude Oil (/CL) inched higher to $69.87 per barrel.

Just in

The May Producer Price Index (PPI) shows wholesale costs flat to lower, as Wall Street had expected. The -0.3% headline figure fell the most since March, while core PPI of +0.2% came in equal with analysts’ forecasts after a 0.2% increase in April. The headline figure was helped by a big drop in fuel costs, but the core number strips out volatile food and energy prices.

On an annual basis, May PPI rose 1.1% and core PPI rose 2.8%, compared with April increases of 2.3% and 3.3%, respectively. In general, the report shows that goods prices fell while services prices continued to climb.

Keep in mind that PPI often can help investors sense the future path of consumer prices. When companies pay less for goods from wholesalers, they might not need to jack up prices on their own customers.

Recent retailer earnings reports suggest consumers are delaying discretionary spending because of inflation. Retailers may want to hold the line on prices if they sense that, but rising labor costs could be a barrier. Entering Wednesday, core PPI growth, which strips out volatile food and energy, had been 0.2% or below for months.

Eye on the Fed

Chances of a pause to interest rate hikes at today’s FOMC meeting stand at 94% this morning, according to the CME FedWatch tool, which also prices in a 64% chance that rates will rise by July. In addition, the market sees a 75% chance that rates will finish the year somewhere between 5% and 5.5%.

Here’s what to watch as the Fed issues its statement at 2 p.m. ET today and Fed Chairman Powell takes the podium shortly after:

• What do the updated FOMC projections signal for rates this year and next? The last FOMC dot-plot, issued in March, forecast a terminal, or peak, 2023 range of 5% to 5.25%. That range is expected to rise about 25 basis points in today’s projections, according to Kathy Jones, Schwab’s chief fixed income strategist.
• The Fed has underestimated the terminal rate for two years. Will today’s updated median hold? It might be useful to check dots near the top of the estimate range to see how high the FOMC’s pessimists think rates might go. One estimate last time was near 6%.
• What are the FOMC’s median projections for 2023 and 2024 unemployment, inflation, and Gross Domestic Product (GDP) growth?
• How will Powell explain the likely decision to “skip” a hike rather than keep the pause button pressed? What type of language does the Fed’s statement use to justify the “skip?”
• Will any FOMC policymaker dissent on the pause decision? Some FOMC hawks might want rates to keep climbing. Hiking decisions have been unanimous over the last year.

Don’t be surprised if Powell takes a hawkish tone in his press conference. He may want to keep market participants primed for more rate hikes if the Fed doesn’t see inflation and labor market progress before the July 25–26 FOMC meeting. June job openings data, due out in early July, could be key after the May report showed an unexpected jump. The Fed is focused on normalizing labor conditions to ease wage growth and accompanying inflation, but that’s tough with job openings more than 50% above prepandemic norms.

The European Central Bank (ECB) is expected to issue a rate decision Thursday followed by the Bank of Japan (BoJ) on Friday. Analysts predict the ECB will raise rates by 25 basis points and the BoJ will maintain its current stance.

What to Watch

Retail sales in queue: The data tsunami continues Thursday before the open with May Retail Sales. Analysts expect a flat reading following April’s 0.4% climb. Excluding auto sales, analysts see a 0.1% rise, according to Briefing.com.

Excepting an energetic January, retail sales have been lackluster since last November. That might seem puzzling given the low unemployment rate and rising wages. But retail sales aren’t adjusted for inflation, so slowing sales could reflect easing price growth. Also, recent consumer surveys show sentiment remains relatively low. The Retail Sales report’s breakdown is a good gauge of not just where people are spending money but also where inflation is growing. For instance, a 0.6% April jump in food services and drinking place sales likely reflected rising prices for those things.

Job fair: Tomorrow morning the Labor Department also releases weekly initial jobless claims, which reached 261,000 last week—their highest level since November 2021. Analysts expect 251,000 in Thursday’s report, still above the average seen over the last few months. If claims are near that level, it could reinforce ideas that the post-COVID 19 labor market surge is easing and be a positive sign for the inflation battle.

Stocks in the Spotlight

Home Ec: Stay tuned today for a word from the housing market later today when home builder Lennar LEN reports quarterly earnings. As always, new orders and prices are likely to come under scrutiny. When the company last reported in March, it said new orders in Q1 fell 10% from a year earlier. At that point, Lennar noted pressure from rising interest rates but also a “significant national shortage” of housing that could be seen as bullish for the company and industry. Shares of Lennar hiccupped in late May, but they recovered recently and are outpacing the S&P 500 so far this year. KB Home KBH, another homebuilder, is expected to report next week.

Stocking shelves: Earnings from Kroger KR get delivered early Thursday, and the grocery company has big shoes to fill after its solid performance in the previous quarter. Kroger’s private-label brands and groceries in general performed well earlier this year as shoppers focused on essential purchases rather than discretionary items, analysts say. Kroger issued solid guidance for 2023, so we’ll see how it’s playing out so far.

Halfway point: Schwab’s Mid-Year Market Outlook is available, including a report card on trends seen so far this year by Schwab’s Chief Investment Strategist Liz Ann Sonders and Senior Investment Strategist Kevin Gordon.

CHART OF THE DAY: WHAT’S THE VECTOR? When you hear people talking about key elements driving the Fed’s future rate path, they often mention jobs growth, inflation, and GDP. But you hear less about job openings, seen in this chart going back the last two decades. They’ve fallen slightly since their postpandemic peak but remain nearly double their average since 2013. All these openings could continue driving wage-generated inflation. Data source: Federal Reserve’s FRED database. Chart source: The thinkorswim® platform from TD Ameritrade. FRED® is a registered trademark of the Federal Reserve Bank of St. Louis. The Federal Reserve Bank of St. Louis does not sponsor or endorse and is not affiliated with TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

Price check: Some might wonder why the market still sees rate hikes ahead despite May CPI growth of 4% being down roughly 50% from the peak. A 0.3% May increase in services inflation less food, shelter, and energy (an important metric the Fed watches closely) also showed signs of progress, rising 3.4% year-over-year, down from 3.7% in April. However, these levels, along with annual core CPI of 5.3%, remain well above the Fed’s 2% goal, and policymakers aren’t likely to budge from their target for fear of losing credibility. In fact, the Fed may be emboldened to keep raising rates, because doing so arguably hasn’t caused much economic damage aside from contributing to bank failures earlier this year. The credit market remains generally resilient despite that. Keep in mind that the Fed has a “dual mandate” to maintain price stability and foster maximum employment. If you ever thought the Fed couldn’t fight inflation without hurting the labor market, you’ve been proven wrong this year. Inflation keeps falling even as labor conditions remain historically strong.

Fed looks ahead: Though unemployment remains near 50-year lows, the Fed projects joblessness to rise as the year continues. Back in March, the FOMC’s median forecast for 2023 unemployment was 4.5%—quite a leap from the current 3.7% level. FOMC policymakers see unemployment rising to 4.6% in 2024 and 2025. Meanwhile, the median FOMC projection for core Personal Consumption Expenditures (PCE) inflation is 3.6% this year and 2.6% next year. The FOMC’s fresh inflation and unemployment forecasts today could help investors glean how much damage the Fed thinks the labor market might sustain as the central bank continues trying to clip inflation growth.

Optimists’ club: Many analysts think the Fed’s last projections looked too rosy, pricing in a “soft landing” that may not actually be in the cards. If the Fed in its projections today sees less inflation progress and higher unemployment ahead, that might reinforce views that a soft landing is far from assured. For reference, the most negative FOMC projections by individual policymakers in March were for 5.2% unemployment in 2024 and 3.1% core PCE inflation.

Calendar

June 15: May Retail Sales, May Industrial Production, June Empire State Manufacturing, and expected earnings from Kroger (KR).

June 16: Preliminary June University of Michigan Consumer Sentiment.

June 19: Markets closed for Juneteenth, a U.S. federal holiday.

June 20: May Housing Starts and Building Permits and expected earnings from FedEx (FDX).

June 21: No major data or earnings expected.

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

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