Calm Before the Storm: Markets Subdued Ahead of Fed Announcement, with 75 Basis-Point Hike Expected

(Wednesday Market Open) Welcome to “Fed Day,” and get ready for even higher interest rates. The CME FedWatch Tool puts odds at nearly 90% of the Federal Open Market Committee (FOMC) raising rates 75 basis points this afternoon for the fourth meeting in a row.

As with most FOMC meeting days, the real story isn’t so much the Fed move (which the market has telegraphed) as what Fed Chairman Jerome Powell says in his press conference after the 2 p.m. ET decision. Investors should tune in for any hints about how the central bank could move rates in December.

Chances are nearly even for a 50-point or 75-point move next month, the FedWatch Tool shows. We’ll see which way the pendulum swings during and after Powell’s comments, as the market can and often does respond quickly and dramatically to anything a Fed chairman says.

It’s also important to listen for Powell’s thoughts on where tighter Fed policy is having an impact and where central bankers hope to see better results. The housing market, for instance, seems to be slowing significantly. But when does Powell think the labor market might follow in order that wage growth—and presumably spending—begin to slow? 

This brings us back to yesterday’s JOLTS job openings data for September. The report was bitter medicine for anyone hoping the Fed might sweeten its words today. Job openings accelerated to 10.7 million from a revised 10.3 million the prior month. Analysts who expected a drop to below 10 million proved far too optimistic.

Markets are subdued this morning ahead of the Fed decision and may stay that way until the announcement. Consider this the calm before the storm.

An Unwelcome “Jolt”

Yesterday’s JOLTS data quickly erased early stock market gains. Treasury yields, which had been down Tuesday morning, popped higher on the data. Job openings remain way above pre-pandemic levels of eight million or below as employers struggle to fill positions.  

Rising job openings mean several things for the economy, most of them bad:

• When workers are scarce and demand is high, companies often must pay higher wages to attract new employees.
• Higher wages hurt company margins, putting pressure on future earnings per share. Net profit margin for S&P 500® companies is down for the fifth-straight quarter, according to FactSet, partly reflecting higher costs companies face. Wages are among those.
• Companies fighting higher costs sometimes pass them along to customers, feeding stubbornly high inflation. Many staples companies reporting in Q3 said demand for their goods remained elastic despite rising product prices. But wage gains haven’t kept up with inflation, making it unclear how long the elasticity can last.

Despite everything the Fed’s tried to do to slow things down, there appear to still be too many companies chasing too few workers. This raises questions whether the Fed has been too optimistic about how high rates need to rise to slow down wage and price growth.

Today’s ADP jobs report could add to the pressure the Fed faces. It showed higher-than-expected growth of 239,000 in October with annual pay up 7.7% year over year. However, the bulk of that growth was in the Leisure/Hospitality and Transportation sectors while the goods-producing Manufacturing sector saw a 20,000-job decline.

It’s noteworthy that the report showed manufacturing taking a hit but services coming in solid. However, looking ahead to Friday, it’s not unusual to see the monthly Nonfarm Payrolls numbers completely refute the ADP report.

The JOLTS report—along with yesterday’s slightly above expectations ISM Manufacturing Index and Construction Spending data—puts additional pressure on the Fed not just to come through with today’s expected 75-basis-point rate hike but also to continue a hawkish stance. We’ll see if Fed Chairman Jerome Powell refers to the data in his speech or press conference after the decision.

The market seems divided on whether the Fed needs to raise rates another 75 basis points in December or just 50, but the CME FedWatch Tool continues to project higher than 50% chances of the Fed’s benchmark rate rising to 5% or above by next summer. That’s above the Fed’s own projections, which get updated next month when it releases its quarterly dot plot.

Potential Market Movers

All this strong data follows weeks of mostly better-than-expected initial weekly unemployment claims, raising chances that Friday’s Nonfarm Payrolls Report for October will also look hotter than the Fed would likely prefer. Wall Street’s consensus for the headline jobs number crept up from 220,000 late last week to 225,000 this week so far. That’s down from 263,000 in September but probably not a significant slowing and still historically high. Keep an eye on Thursday’s September Factory Orders data for an early hint. If it remains strong, it might reflect growing consumer confidence as more people find employment.

One bullish nugget in Tuesday’s data was the Prices Index category of the ISM Manufacturing report, which fell to 46.6. That was the first sign of declining prices in that category since May 2020.

Tomorrow brings weekly initial jobless claims. Consensus stands at 225,000, according to Briefing.com, up a bit from 217,000 the previous week.

Streaming company Roku ROKU is expected to report after the close Wednesday, putting focus on the slowing digital ad space. Starbucks SBUX is expected after the close Thursday, and investors could be watching for its holiday season forecast and any issues the company might be having with its China business.

While We Slept

Here’s our quick take on a few things we learned before the open:

• Chip maker Advanced Micro Devices AMD became the latest company in the semiconductor space to miss Wall Street’s earnings projections, but its revenue rose 30% to closely match Wall Street’s expectations. In the case of AMD, softness came as no surprise after the company warned last month that declining personal computer (PC) demand would trim revenue. 
• We keep hearing CEOs talk about how consumers right now want “experiences” rather than goods. More evidence of that came in yesterday afternoon’s earnings as both Caesar’s Entertainment CZR and Airbnb ABNB beat Wall Street’s earnings and revenue estimates during their respective quarters. ABNB’s executives painted a positive picture of travel growth, including what they said is the continued recovery of international travel. However, ABNB shares fell sharply ahead of the open, with investors apparently discouraged by the company’s holiday season projections.
• Eating is another experience, and Yum Brands (YUM) chowed down last quarter on revenue but came up a bit hungry in the earnings department, missing Wall Street’s earnings per share consensus. Taco Bell and KFC had solid sales increases. Shares rose slightly in pre-market trading.
• In other earnings news this morning, CVS Health (CVS) beat Wall Street’s earnings and revenue estimates and offered guidance in line with the Street’s projections. Shares rose.
• Russia agreed to rejoin a deal allowing Ukranian grain shipments. This could cool off commodities markets. Wheat futures dropped this morning on the news.
• European PMI data came in below expectations and showed manufacturing in contraction across most of the region.

Reviewing the Market Minutes

The $DJI sank 0.24% to 32,653,20 on Tuesday, the Nasdaq® ($COMP) fell 0.89%, and the S&P 500® index (SPX) slipped 0.41% to 3856.10. Small-cap stocks continue to show strength (see below).

The Cboe Volatility Index® (VIX) is a little higher this morning but remains in the mid-20’s, which is a good sign. The 10-year Treasury Yield (TNX) is pushing back toward 4%, but we’ll see where it goes after the Fed meeting.

CHART OF THE DAY: OLD SCHOOL. October was the best month for the Dow Jones Industrial Average® ($DJI—candlesticks) since the administration of President Gerald Ford, but the S&P 500® index (SPX—purple line) wasn’t half bad, either, rising nearly 8%. The Nasdaq ($COMP—blue line) brought up the rear as many investors appeared to move out of the tech sector that propelled so much of the post-pandemic rally and into “old economy” sectors like energy, industrials, and materials that are better represented in the $DJI and SPX. The question is whether this trend can continue with the Fed still raising rates and the dollar showing few signs of retreat. Data Sources: Nasdaq, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

Next I Bond Rate Is 6.89%: If you were able to get in under the wire last Friday, you’d be earning more, but the new inflation-protected I Bond rate isn’t exactly a slouch return if you have up to $10,000 in cash (or as little as $25 if you’re teaching a money lesson to kids) that you can afford to tie up for a year. The U.S. Treasury said yesterday that Series I Bonds will pay 6.89% through next April, down from the previous 9.62%. Each I Bond keeps its value and earns monthly interest two ways—a fixed rate that stays put after purchase and a variable rate changing every six months tied to inflation. I Bonds are available online with other savings bonds offerings on the government’s TreasuryDirect website.

Pandemic “Buffers” Holding: In the early months of COVID-19, government stimulus payments helped many Americans put aside a little more in savings than they typically had up until that point. Higher wages helped too. A Bank of America Institute study indicated that some of these savings “are gradually being drawn on, particularly among lower-income households,” but there’s little evidence of a “sharp rise in people living ‘paycheck to paycheck.’” If the economic slowdown is “gradual,” the bank said it expects these “accumulated buffers to continue to support consumers for a significant period.” For more on that, watch the Fed.

Small-Caps Keep Climbing: Like that famous riverboat, the Russell 2000® (RUT) kept on rolling Tuesday and powered its way to nearly two-month highs within shouting distance of its 200-day moving average (MA) of 1883. Industrials and health care are the two heaviest-weighted sectors in the RUT, and they are two of the four best-performing sectors over the last three months. It also helps that RUT has lower weightings toward two of the worst-performing sectors over that time period: communication services and real estate. Another thing that may be coming to RUT’s aid? The strong U.S. dollar that hurts large multinational companies in competing indexes is less painful for the more domestic-oriented companies in the RUT.

Notable Calendar Items

Nov. 3: September Trade Balance and Factory Orders and expected earnings from Exelon (EXC), Hyatt Hotels (H), Illumina (ILMN), Starbucks (SBUX), Kellogg (K), Penn Entertainment (PENN), and Marriott (MAR)

Nov. 4: October Nonfarm Payrolls Report and expected earnings from Hershey (HSY), Cardinal Health (CAH), and Duke Energy (DUK)

Nov. 7: September Consumer Credit and expected earnings from Palantir (PLTR), Lyft (LYFT), and BioNTech (BNTX)

Nov. 8: Election Day and expected earnings from DuPont (DD), AMC Entertainment (AMC), Occidental (OXY), Walt Disney (DIS), and Wynn Resorts (WYNN)

Nov. 9: September Wholesale Inventories and expected earnings from D.R. Horton (DHI), Wendy’s (WEN), and Rivian (RIVN)

Nov. 10: October Consumer Price Index (CPI) and expected earnings from Ralph Lauren (RL), AstraZeneca (AZN), and Dillard’s (DDS)

Nov. 11: Preliminary November University of Michigan Consumer Sentiment

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

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