The Main Event: Powell Speech Front And Center After Mixed Messages From Fed

As the saying goes, welcome to the main event.

Fed Chairman Jerome Powell’s 10 a.m. EDT speech at the “virtual” Jackson Hole conference could set the tone. The market’s behavior the rest of the day may hinge on how “hawkish” or “dovish” traders decide he sounds. We’ve had such mixed messages this week from other Fed governors that it’s really hard to say which way things might go. 

It may seem simple for the Fed. Should it continue the current pace of $120 billion a month in bond purchases designed to stimulate the economy by putting pressure on borrowing costs? Or is it time to pull back following big recent inflation gains that some critics say the Fed’s policy could be exacerbating? And if it does pull back, when should it begin doing that, and by how much? 

The decision really isn’t simple at all when you consider Covid hospitalizations reaching new highs in parts of the country, signs of economic data weakness both here and overseas, and uncertainty about what kind of infrastructure and budget bills might get through Congress. 

Several Fed presidents said early yesterday they think it’s time for the Fed to pull back on the stimulus, and the question is whether that was a sneak preview of anything. It’s possible but debatable. Powell doesn’t always agree with all the Fed presidents. The caution he’s shown throughout Covid has some analysts believing he won’t say anything too noteworthy today.

It’s unclear how the market might react. A more hawkish-sounding Powell helped send stocks down back in mid-June and could potentially do that again today, but if he stays on the dovish side and doesn’t provide more clarity, there might also be a disappointment on Wall Street. 

Many investors believe the Fed will taper sooner rather than later, and they’re looking for a roadmap. Until they get one, this sense of uncertainty might make it hard to find direction and could promote more intraday volatility in the coming weeks as every data point starts to assume more significance (see more below). 

Consider looking for a possible transcript of Powell’s speech soon after the open today, because the Fed sometimes issues his remarks before he takes the podium. The market could potentially trade on his words even before he starts speaking. It sounds weird to say, but it’s happened before. 

First Losing Day In A Week Ahead Of Powell

After a five-session win streak, Thursday’s moderate Wall Street losses shouldn’t have been too unexpected. Nothing goes up forever, and there may have been some profit-taking going on ahead of Powell’s speech. The market started Thursday lower, and the tragedy in Afghanistan appeared to add to the selling. 

Volatility also advanced going into the speech, with the Cboe Volatility Index (VIX) scraping up against 19 yesterday following lows earlier this week near 17. When VIX goes up, it can often signal that some investors are trying to get some protection ahead of a big event. The historic average for VIX is around 20, so things aren’t really out of whack. It doesn’t feel like a big concern at current levels below 20. 

Looking at the damage from Thursday, it’s interesting to see that some of the same sectors that carried things higher earlier this week were the loss leaders. Those include Energy and Consumer Discretionary. The best performers yesterday were Real Estate and Utilities, which are traditionally seen by many market watchers as more “defensive” areas of the market where people go when they’re nervous. 

Another place nervous traders sometimes go is the fixed income market, but that didn’t really go along with the trend yesterday. Bonds actually fell in some cases, helping the 10-year yield climb slightly to near its highs for the week around 1.35%. People may be selling bonds amid talk that the Fed could possibly come out of Friday’s Jackson Hole conference sounding more hawkish. 

That’s one school of thought. The other is that Powell could kick the ball down the road when it comes to timing the taper. The Fed may want to see August’s jobs number at the end of next week before committing to anything because that report could give a better picture of how and whether the Delta variant is affecting employment. 

Anyway, there’s actually some other stuff happening out there besides interest rates and Afghanistan. Southwest LUV is cutting its flight schedule for the rest of the year due to staffing issues and cancellations, so that’s not good news. And some retail and manufacturing companies are talking about possible supply chain issues heading into the holidays, so that’s something we might want to keep an eye on. 

In data news, personal consumption expenditure (PCE) prices rose 0.4% in July, which matched Wall Street’s consensus expectation and was down from 0.5% the month before, the government said. Core PCE prices rose 0.3%, the lowest growth since February. That’s likely going to be seen as good news. The negative element of the report is that personal spending and income growth slowed. Could this mean the Delta variant is starting to weigh on the economy? It’s possible. 

Peloton, Salesforce Go Opposite Ways

Unlike earlier this week when reopening stocks shined, Thursday was an equal-opportunity day for losses. One of the worst performers after the close was Peloton PTON, a so-called “stay at home” stock that really rolled up the gains in 2020. Shares got pounded in after-hours trading yesterday after the company’s earnings and outlook appeared to disappoint traders. To rub salt in the wound, the company then announced it’s been subpoenaed by the Justice Department for over-reporting of treadmill injuries. 

Other “stay at home” stocks, including most of the semiconductors like Advanced Micro Devices AMD and Nvidia NVDA also headed lower toward the end of the week, while  “reopening” stocks like airlines and hotels also took it on the chin. It felt like people were just in a cautious mood pretty much all around Thursday. One exception was Salesforce CRM, which climbed after a strong earnings report.

CHART OF THE DAY: GREEN VS. GOLD. Going into the Fed’s Jackson Hole symposium today, the dollar ($DXY—candlestick) has been outshining gold (/GC—purple line) pretty consistently over the past three months. In an interesting move, however, the gap between the two has closed slightly over the last few weeks. A slight decline in the dollar from its peak early this month could suggest people are betting on the Fed to stay dovish. Data sources: ICE, CME Group.  Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Number Crunching: As noted above, if the Fed doesn’t share more thoughts soon on a possible taper or its timing, the data from here on could start to gain more significance as people continue trying to figure out what the Fed might be thinking based on a close look at the numbers. Even data that doesn’t historically have a lot of influence could start having more of an impact on day-to-day trading. However, the main data that’s key to watch include jobs, inflation, and manufacturing metrics like the Institute for Supply Management report next week. 

Another metric the Fed may look at is consumer sentiment. The University of Michigan is coming out today with its updated sentiment report for August after a very poor showing the first time out. The plunge in the early August sentiment reading to 70.2 from 81.2 in July wasn’t just due to the Delta variant of Covid, research firm Briefing.com said. It reflected overall economic concerns, including inflation and unemployment. Analysts expect this morning’s update to provide little sign of progress, with consensus at 70.7 according to Briefing.com. Consider reading the full report to get a better sense of what the researchers see out there. 

More Room To Run For Banks? The biggest U.S. banks combined for an opening smash to the last earnings season, leading some analysts to wonder how much better things could get on the bottom line for companies like JP Morgan JPM and Goldman Sachs GS. Worries about peak earnings growth haven’t taken the glow off of the Financial sector, however, as it’s led the entire market over the last month with gains of nearly 7%. There may be more tailwinds to come, too. 

The big banks have been run so lean and have done phenomenally with little spread in yields, something that can sap their ability to profit. Looking ahead, there is a chance yields could start to rise as the Fed considers tightening the money supply, and that can probably do nothing but help the banks going forward. Can yields go lower? Certainly, but they’ve been going the other way. The 10-year Treasury yield now stands near 1.35%, which is historically low but up pretty dramatically from near 1.1% less than a month ago. Some analysts think 1.5% isn’t too much to expect in the near future. If yields go up, they would probably go straight to the banks’ bottom line. They could have an opportunity to grow profit faster than some had expected, and that’s arguably how the rally could continue. 

The Daily Grind: There’ve been some quick ups and downs in recent sessions on Wall Street, and it wouldn’t be surprising to see more intraday volatility over the course of the second half amid uncertainties over Covid and Fed policy. Investors may be getting used to this slow upward grind we’ve been having, but don’t get too comfortable, or you might risk becoming complacent. If you’re a long-term investor, it might be a good time to brush off your plans and see if maybe the level of stock exposure in your portfolio may be getting a bit above where you’d targeted due to this market strength. If so, perhaps you might want to consider some rebalancing.

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

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