Set Yellen On Repeat: Fed Chair Back On Capitol Hill After Stocks Rise To Record Highs

Fed Chair Janet Yellen told the market pretty much what it wanted to hear yesterday in her testimony to Congress, putting a charge into stock prices and sending the Dow Jones Industrial Average ($DJI) to new record highs.

Today, Yellen testifies again, but the marquee event of the week — earnings from three major banks — is around the corner Friday morning. Stay tuned before the open tomorrow for earnings from Citigroup Inc C, JP Morgan Chase & Co. JPM, and Wells Fargo & Co WFC. Earnings drive the market, and we get three big ones on the same day.

Clearly the equity market liked much of what Yellen had to say Wednesday, rallying as her prepared speech hit the newswires even before her testimony began. Info tech and real estate led the day with gains of more than 1.3%, but every sector rose. Info tech is now up four days in a row, and the S&P 500 Index (SPX) put in its second-highest close ever. Bonds rallied along with stocks to push 10-year yields down to around 2.31% by the end of the day as the futures market predicted less chance of a near-term rate hike (see below).

Most of the gains yesterday occurred very early on, after Yellen’s testimony was released but before her appearance in front of Congress began. Today might be one of those days where the market bounces around a little ahead of tomorrow morning’s key earnings news, because it seems unlikely that Yellen would change her tone much from what she said in the Q&A yesterday, and her testimony is already public.

Yellen, whose testimony starts today at 10 a.m. ET, said Wednesday that the economy is improving and low inflation looks temporary. Rates don’t need to rise much more to reach their “neutral” level, she added, something that many investors interpreted as dovish and constructive for the stock market. She reinforced that the Fed would begin drawing down its balance sheet sometime this year if the economy performs as anticipated, but didn’t say when.

All this doesn’t mean Yellen’s testimony was vanilla. One interesting part had to do with U.S. trading partners still confronting economic uncertainty and how that might play into the U.S. economy. She also talked about how inflation might respond to what she called “tightening resource utilization.” Another somewhat unsettling passage in her remarks had to do with globalization’s negative impact on the middle class. “We have to take into account factors of the technological change that have eliminated middle-income jobs and globalization that has reinforced the impact of tech," Yellen said.

Looking beyond Yellen, U.S. crude oil stockpiles posted a weekly drawdown of 7.6 million barrels, which was more than analysts had expected. However, U.S. oil production grew slightly, which appeared to take some of the vigor out of the oil market later in the day and early Thursday. Front-month U.S. crude futures continue to pivot around the $45 a barrel level, and rising OPEC production could keep a lid on rallies even if U.S. supplies fall further.

In corporate news, Target Corporation TGT shares surged in pre-market action Thursday after the company raised its Q2 guidance.

From a data perspective, U.S. producer prices for June rose 0.1%, compared with analyst’s consensus for a 0.1% decline, and weekly jobless claims of 247,000 came in a little above Wall Street’s expectations.

FIGURE 1: VIX FLIRTING WITH 9-HANDLE. After spiking from below 10 a mere two weeks ago to above 15 on bearish news from the tech sector, the "fear index" came within a few ticks of piercing the 10 level on Wednesday. Data source: CBOE Futures Exchange. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Beyond the Banks

Big bank earnings may take center stage Friday, but there’s plenty going on in the wings as well, especially before the open. Retail sales and the June consumer price index reports (CPI) both bow at 8:30 a.m. ET, and could be watched a little more closely than usual. Yellen’s contention to Congress on Wednesday that the Fed is seeing strength in consumer spending could be tested by the retail sales data, which analysts expect to rise just 0.1% after a 0.3% decline the previous month, according to Briefing.com. The wild card is whether slow wage growth might be making consumers more cautious about big-ticket items. CPI is expected to be flat, with relatively cheap energy keeping prices down, though core CPI with energy and food excluded is seen rising 0.2%, Briefing.com said.

A Dose of Yellen Eases

Sometimes the appearance of a Fed chair in front of Congress gets people nervous, but that wasn’t the case with Yellen’s testimony Wednesday, perhaps because it was so well telegraphed. In fact, as Yellen’s remarks filtered through, volatility eased appreciably, with VIX falling back toward 10 and the futures market showing lower odds of a Fed rate hike, with odds of around 50% by end of year. The idea seems to be that the Fed is trying to engineer a smooth transition to its balance sheet wind-down, possibly waiting until that’s underway before pushing through another rate hike. The futures market now sees only about an 8% chance of a September hike, and falling rate hike odds might have played into the stock market’s charge to the upside Wednesday. The exception was financials, which didn’t rally with other sectors as bond yields fell.

Taking Flight

Airline stocks found their wings Wednesday, with some major names rising 4% or more, including United Continental Holding Inc UAL and American Airlines Group Inc AAL. The impetus appeared to be AAL hiking its Q2 forecast for unit revenue and adjusted pre-tax margin amid improved passenger demand, media outlets reported. With airlines injecting a wave of confidence, the Dow Jones Transportation Average once again rose to a new record high. Airlines are among some of the earlier-reporting companies, so check what their executives have to say about demand growth. Sometimes transports can provide a good reflection on wider economic performance. Delta Airlines, Inc. DAL missed Wall Street’s earnings and revenue projections early Thursday, so we’ll see if that brings the sector in for a landing.