Fed Minutes Get A Dovish Read, And Focus Shifts Once Again Toward Trade

It appears as though the Fed might be willing to give the economy a bit more running room, and that seems to agree with the market. Stocks recovered from earlier losses Wednesday after the Fed minutes showed a willingness to let inflation run a little above the Fed’s long-term 2 percent target. However, the market picture looked a bit more mixed as Thursday dawned and more retail earnings rolled in.

European and Asian stocks mostly fell early Thursday, and U.S. headlines focused on continued trade talks with China and a Trump administration threat to impose new tariffs on European automobiles. That news appeared to weigh on stocks of automakers, and also brought trade barriers back into focus.

Over on earnings row, Best Buy Co. Inc. BBY posted Q1 earnings of 82 cents a share, above Wall Street analysts’ estimates of 74 cents. Revenue also beat estimates, and same-store sales jumped 7.1 percent. This continued what has generally been a positive earnings season for most of the major retailers. However, shares of BBY slid 5 percent early in the session. Another retailer, Gap Inc. GPS, is scheduled to report after the close today.

Fed Minutes Seen Dovish, Potentially Helpful For Stocks

The key takeaway from what many analysts saw as a dovish set of minutes is that the Fed appears willing to slow the pace of rate hikes. This doesn’t necessarily mean anything for the fast-approaching June meeting, where futures prices have pretty much baked in a hike. It does raise questions, however, about the Fed’s course of action the remainder of the year. Many investors had begun to build in the potential for a fourth hike instead of the Fed’s projected three, but that argument might lose some luster.

Chances for a June rate hike remain extremely high at 90 percent, according to the futures market. However, that’s down from 100 percent a week ago. Chances of another hike by September are now at 70 percent, down from 75 percent a few days ago. As for odds of a fourth hike by the end of the year, futures prices now show a less than 40 percent chance, down from 50-50 earlier this week.

What the Fed appears to be saying is that it plans to err on the side of letting rates stay too low rather than get too high. Make no mistake: There’s risk in this. The Fed is basically saying it’s going to wait and see if it gets a little behind the curve or right on the curve as far as inflation is concerned, but it appears to not want to be too aggressive in raising rates out of fear that an aggressive policy might kill U.S. economic momentum.

The fear with this kind of approach is that if inflation runs too hot, it could be a momentous type of event. If the Fed gets behind the inflation curve, so to speak, it could have to raise rates a bunch of meetings in a row to stake the inflation vampire. A series of quick rate hikes historically tends to weigh heavily on economic growth. At this point, however, the Fed appears willing to take a chance on inflation.

In Fed speech, that sounds like this: “It was also noted that a temporary period of inflation modestly above 2 percent would be consistent with the committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”

And the Market’s Reaction?

Soon after the minutes came out there already appeared to be some market reaction. Rate-sensitive sectors like utilities and consumer staples rebounded a bit late Wednesday, as did consumer discretionary and info tech. If borrowing costs go down, that often benefits growth stocks, while “defensive” sectors can also find buyers in a lower-rate environment as their yields start to compete better with yields on Treasury bonds. Financials, which tend to perform better when rates rise, fell more than any other sector on Wednesday.

The energy sector is another one to watch if the Fed continues to indicate it could keep its foot off the brakes. Energy is already rallying thanks in a large part to fundamental factors, and many energy stocks also pay hefty dividends. Consider keeping an eye on some of the big multinational energy companies to see if they start to benefit as some investors might shop there for yields instead of in the bond market.

Meanwhile, over in the interest rate complex, 10-year yields trade at just below 3 percent. That’s down from last week’s highs above 3.1 percent, though it still remains lofty compared with recent years when the yield fell below 2 percent. The dollar index, however, moved higher Wednesday, perhaps a sign of investor faith that the Fed could allow the economy to continue growing without so much concern about inflation.

Figure 1: Same Fed Minutes, Different Reactions:This one-month chart of the S&P 500 tech sector (candlestick) and financial sector (purple line) shows that they had a different response late yesterday to Fed minutes. Tech and other growth sectors generally climbed, but financials slumped amid worries that a potentially less hawkish Fed might hurt big bank profits. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Stepping Back

All year it seems like every couple of steps bond yields move higher, they take another step back. The same thing happened over the last week when the benchmark 10-year Treasury yield, which climbed to a multi-year high of 3.11 percent a week ago, pulled back to just below 3 percent early Thursday. The impetus for yields stepping back this time might have been geopolitical as many investors began to worry that trade talks with China weren’t proceeding as smoothly as some had thought earlier in the week. The dovish Fed minutes later Wednesday seemed to add to the bond rally. Remember that despite all the market stress as yields climbed from around 2.4 percent in January over 3 percent earlier this month, any move backward is also potentially an issue. That’s because climbing yields can often signal investor confidence in the U.S. economy and vice versa.

Survey Says

About 10 years ago when gas prices first topped $4 a gallon, many car shoppers began gravitating toward smaller and alternative-fuel vehicles. Now, with gas at $3 a gallon nationwide this month after several years below that level, the question for automakers is how high gas prices might go before customers might once again consider smaller cars. An online survey of vehicle owners and shoppers by Kelley Blue Book, an automotive research company, appeared to have one possible answer. The “reasonable” price for a gallon of gas is $2.50, the survey respondents said, and respondents indicated $4 a gallon is the tipping point where fuel costs would greatly affect the type of vehicle a person will purchase. About 40 percent of the 400 people surveyed said it was “likely” or “extremely likely” that they’d consider a more fuel efficient vehicle due to the rising price of gas.

Flying on the Ground

It’s been a while since we looked at airline stocks, and that’s in part because they just haven’t been flying too high this year. Overall, airline stocks are down about 10 percent since mid-March, something many analysts blame on higher oil prices that can crimp margins. Of the major U.S. airlines, United Continental Holdings Inc. UAL is the only one with solid gains since the broader market hit its low so far for 2018 back in early February, while Delta DAL is up a touch since then. Southwest Arilines Co. LUV, Alaska Air Group, Inc. ALK, and American Airlines Group Inc. AAL are all down since the market’s February descent, meaning they’re performing far worse than the S&P 500 (SPX). They’re also doing worse than the Dow Jones Transportation Average ($DJT), which is up about 5 percent over that time period. Still, valuations of the major airline stocks are lower than the S&P 500 (SPX) and summer travel season is fast approaching, Reuters noted in an article this week. Maybe those factors can give airlines a lift. We’ll have to wait and see.

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