Suspense Builds: Fed Expected to Keep Rates on Pause, but Economic and Rate Projections Seen Key

(Wednesday market open) Welcome to Fed Day. Major indexes clawed back into the green in premarket trading, boosted by falling crude oil prices and lower Treasury yields. But trading might lack direction in the hours leading up to the Federal Reserve’s decision on interest rates if historic trends hold.

The Federal Open Market Committee’s (FOMC) meeting concludes at 2 p.m. ET today, and the futures market builds in a 99% chance that it will stand pat on rates, keeping the target between 5.25% and 5.5%.

The rate decision holds little drama. The suspense lies in the FOMC’s economic projections and its dot-plot projecting the path of future rates. Will the FOMC still build in one more hike this year as it did in June? And will it maintain its 4.6% rate projection for the end of 2024 or raise it to reflect that rates should stay “higher for longer,” as some policymakers have implied?

Higher rate projections would conceivably interfere with the market’s ideas that the Fed could start trimming borrowing costs by the middle of next year. A major upward revision to that 4.6% figure might even affect how Wall Street sees future earnings and economic growth.

As always, how the Fed frames things could influence the market’s reaction. In his press conference after the decision, Fed Chairman Jerome Powell might emphasize continued vigilance on inflation despite the anticipated rate pause.

“The start of rate cuts has been moved into Q2 of 2024, but the key will be how and if Powell addresses this and pushes back on near-term rate cuts, reinforcing the “for longer” part of ‘higher for longer,’” says Liz Ann Sonders, Schwab’s chief investment strategist.

Morning rush

• The 10-year Treasury note yield (TNX) fell two basis points to 4.34%. It hit a 16-year high Tuesday.
• The U.S. Dollar Index ($DXY) eased slightly to 105.
• Cboe Volatility Index® (VIX) futures were steady at 14.12.
• WTI Crude Oil (/CL) slipped 0.75% to $90.52 per barrel.

The 10-year Treasury note yield edged to fresh 16-year highs yesterday despite solid demand at a 20-year bond reopening. (A reopening is when the Treasury Department issues additional amounts of a previously issued security.) Firm demand typically weighs on yields, which move the opposite direction of prices. But Treasury and corporate supplies have swelled this summer and fall, pressuring the market and sending yields skyrocketing.

Yesterday’s stock market action reflected the impact of higher yields and climbing crude oil. Both the Dow Jones Transportation Average (DJT) and Russell 2000 Index (RUT) ended at their lowest levels since late June. Technology companies were also lower, with the Philadelphia Semiconductor Index (SOX) down more than 1%. Tech, small-caps, and transports are historically more vulnerable to high yields and crude.

From a technical perspective, the S&P 500® Index (SPX) remains in a long-term range between summer lows of 4,350 and summer highs of 4,600. The 50-day moving average now near 4,484 has been a pivot point.

What to watch
Rate alert: The Fed’s not the only central bank in the spotlight this week. The Bank of England’s (BoE) next rate decision is scheduled tomorrow morning, U.S. time. A “dovish hike” might occur, says Michelle Gibley, director of international research at the Schwab Center for Financial Research. Recent votes have shown some disagreement among policymakers, meaning this week’s anticipated move could be the BoE’s last hike, she adds. A softer-than-expected inflation reading released earlier today might bolster ideas that the BoE is just about done.

The Bank of Japan (BoJ) announces a rate decision on Friday. Analysts expect no move, but the BoJ may be close to starting a rate-hike cycle after staying on the sidelines the last two years while other central banks raised rates.

Back home, another major report to watch is weekly Initial Jobless Claims, due out before the open tomorrow. Consensus is 225,000, up from 220,000 the prior week, according to Briefing.com. Ironically, the overall jobs market seems to be cooling if you follow the monthly Nonfarm Payrolls report, but weekly claims haven’t reflected that. They’ve recently fallen well off the pace from earlier this summer, which suggests this isn’t a layoff-driven slowdown in the jobs market.

Two more reports to watch just after the open tomorrow are The Conference Board’s Leading Economic Index and Existing Home Sales for August. See more below.

Stocks in Spotlight
Earnings on tap: Shipping firm FedEx (FDX) reports after the close and might face margin pressure as worker pay mounts around the industry. Shipping rates have risen, too, but the question is how much room FedEx has to raise prices for inflation-weary customers.

KB Home (KBH) also reports after the close today. Homebuilder stocks have generally performed well, in part due to a shortage of housing. The August Housing Starts and Building Permits report released yesterday showed permits exceeded estimates at 1.543 million and were the highest since last October, driven almost completely by multi-family housing. But housing starts were lower than expected.

From homes to hearth: Darden Restaurants (DRI) serves up its earnings report tomorrow for the latest taste of how the casual dining industry is getting along. Olive Garden makes up about 45% of Darden’s sales, but the company has a fine dining segment as well, as it recently bought Ruth’s Chris Steak House. This will be the first quarterly earnings data to reflect that purchase. Darden beat analysts’ earnings expectations last time out and matched Wall Street’s average revenue estimate.

Eye on the Fed
As of this morning, the probability that the FOMC will maintain current rates after today’s meeting is 99%, according to the CME FedWatch Tool. The tool pegs the probability of rates being higher after the November meeting at around 30%. There’s a 38% probability priced in that rates could be a quarter-point higher coming out of the December meeting, and chances of a rate cut by next June approach 50%.

FOMC members predicted in June that rates would finish the current year between 5.5% and 5.75%. That’s a quarter-point above current levels. Some analysts predict a “hawkish pause” because they believe the Fed’s projections may leave the door open to one more hike this year. Even if the Fed doesn’t hike again in this particular cycle, “tightening will continue via higher real yields and the balance sheet runoff,” notes Cooper Howard, director of fixed income strategy at the Schwab Center for Financial Research.

The Fed’s June projections and dot-plot looked like this:

• 2023 GDP growth: 1%, versus the March projection of 0.4%
• 2023 unemployment rate: 4.1%, versus March projection of 4.5%
• 2023 core PCE inflation: 3.9%, versus March projection of 3.6%
• 2023 Federal funds rate: 5.6%, versus March projection of 5.1%
• 2024 Federal funds rate: 4.6%, versus March projection of 4.3%

Forward view: Get the latest perspective on markets and the economy from Schwab Chief Investment Strategist Liz Ann Sonders in her monthly Market Snapshot video.

CHART OF THE DAY: SWEET SIXTEEN: This 20-year chart of the U.S. 10-year Treasury note yield shows that it last traded at current levels all the way back in October 2007, almost exactly 16 years ago, meaning babies then are getting their drivers’ licenses now. Data source: Cboe.Chart source: thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap
Ideas to mull as you trade or invest

Leading downhill: The U.S. economy still appears to be in a long “rolling recession,” in which various sectors see the impact at different times. Certain features that historically signal recession, including The Conference Board’s Leading Economic Index and the inverted Treasury yield curve—have flashed recession warnings for nearly a year. That’s expected to continue tomorrow morning. Consensus is for a 0.5% monthly decline in August following a 0.4% drop in July, says Trading Economics. Leading Indicators, which track where the economy is heading, have fallen for 16-consecutive months. Still, The Conference Board’s coincident index, tracking where economic activity stands now, has grown slowly but inconsistently. Watch the August data for any deterioration in current conditions and check for any changes in The Conference Board’s outlook. Last time, it predicted a “short and shallow recession” in the Q4–Q1 period.

Unrolling? One positive aspect of a rolling recession is a “rolling recovery.” As some economic sectors slow, others pick up the pace. At least that’s how it’s supposed to work, but rising crude oil prices toss a wrench into that scenario. The hope for rolling recoveries is “uncertain given the spike in oil prices,” says Schwab’s Sonders. While crude oil doesn’t have as big an impact as it did 40 or 50 years ago, it can factor into inflation and consumer sentiment. Transport stocks—particularly vulnerable to crude—have fallen nearly 10% from their early August peak, as measured by the Dow Jones Transportation Average ($DJT). That’s far worse than the SPX’s 3% drop over the same period. Earnings this afternoon from FedEx might shed light on the sector’s struggles and consumer demand heading into the holidays.

This old home: Existing Home Sales for August tomorrow could provide insight into whether the shelter component of inflation is easing. Shelter costs contributed more than their share of fuel to the 2022 inflation fire, but rising interest rates splashed some water. “The recent slowdown in asking rents and house prices is likely to slow shelter inflation significantly in the future,” the San Francisco Fed said in a report last month. Its forecast shows shelter inflation turning red by mid-2024, likely making the Fed’s inflation-fighting job easier and possibly playing into the market’s forecast of at least 75 basis points in rate cuts by the end of 2024. Analysts see existing home sales nearly steady at a seasonally adjusted annual rate of 4.1 million, Briefing.com says. Median home prices rose year-over-year in July for the first time in months, so we’ll see if that had any legs in August. Existing home prices are underpinned by supply shortages, as many homeowners are reluctant to sell and take on higher mortgage rates.

Calendar

• Sept. 21: August Existing Home Sales, August Leading Indicators, and expected earnings from Darden Restaurants (DRI).
• Sept. 22: No major earnings or economic data.
• Sept. 25: No major earnings or economic data.
• Sept. 26: September Consumer Confidence, August New Home Sales, and expected earnings from Costco (COST).
• Sept. 27: August Durable Goods and Durable Orders and expected earnings from Micron (MU).

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