Stocks on Pace to Retest Summer's Lows as Investors Digest Fed's "Higher for Longer" Message

(Thursday market open) Treasury yields soared to new 16-year highs and the dollar posted fresh gains early Thursday, adding to pressure on stocks following the Federal Reserve’s “hawkish pause.”

“Higher for longer” was what many investors anticipated—and what they got—from the Fed at yesterday’s Federal Open Market Committee (FOMC) meeting. Though it wasn’t unexpected, news that the FOMC expects current elevated interest rates to last further into next year hit Wall Street like a brick.

“The overriding message from the Fed is that it will continue to keep rates high until inflation comes down,” says Kathy Jones, chief fixed income strategist at Schwab. “This ‘higher for longer’ message reflects a high level of uncertainty at the Fed about what it will take to move inflation sustainably lower.”

The FOMC’s dot-plot projections of the future rate path kept one more hike built in for 2023 and effectively removed two cuts from 2024. It was the 2024 projections that arguably slammed stocks hardest, dashing hopes for as many as four rate cuts next year that would have taken rates down to near the Fed’s June projection of 4.6%. Now the best-case scenario—if the FOMC projections prove prescient—is two rate cuts in 2024, taking the target Fed funds range to 5%–5.25%.

That’s only a quarter-point below current levels following the FOMC’s pause Wednesday. High rates tend to slow economic growth and hurt the consumer, potentially damaging Wall Street analysts’ double-digit earnings growth projections for 2024.

“The big question facing the markets is: Are we at the peak in the federal funds rate for the cycle, or are there more rate hikes ahead?” says Jones. “Based on the dot-plot, the consensus still looks for one more rate hike this year, and the size of rate cuts in 2024 diminished somewhat. Investors should prepare for a sustained period in which the markets will react to each incoming economic report to try to gauge what it will mean for Fed policy. That could mean more volatility ahead.”

Morning rush

• The 10-year Treasury note yield (TNX) jumped 11 basis points to 4.46%.
• The U.S. Dollar Index ($DXY) reached new six-month highs of 105.66.
• Cboe Volatility Index® (VIX) futures jumped to 16.26, the highest in nearly a month.
• WTI Crude Oil (/CL) hit a one-week low below $89 and now trades at $89.42 per barrel.

Rate-sensitive sectors took it on the chin yesterday, with communication services and technology being the worst performers. The Philadelphia Semiconductor Index (SOX) hit its lowest level since late May and regional banks also stumbled. The U.S. Dollar Index (DXY) climbed toward a six-month high, aided by the outlook for higher rates. A strong dollar tends to hurt sectors more dependent on overseas revenue, including industrials, materials, and tech.

The so-called “mega-caps” are under pressure again in premarket trading. That may have an outsized impact on the performance of the broader market.

“We should be on the lookout for spreading weakness today,” says Kevin Gordon, senior investment strategist at Schwab. “It is still the case that banks are down since the market’s October low; and that marks the first time in 100 years that, after a major market low, they have not rallied.”

Just in
The Bank of England (BoE) left rates unchanged today after 14 straight increases, but there’s growing dissension in the ranks as the pause vote came in at 5–4. The British pound fell against the dollar following the news, giving the rising dollar another source of strength.

Weekly Initial Jobless Claims slid to 201,000 versus 221,000 a week earlier, the lowest level since January and another sign that the labor market remains in good shape. The Philadelphia Fed Manufacturing Index for September was –13.5, much lower than analysts’ expectations for –4.0, according to Briefing.com. Readings below zero denote contraction. It was also a reversal from a strong expansion of +12 the prior month, suggesting the manufacturing sector isn’t out of the woods.\

Eye on the Fed
As of this morning, the probability that the FOMC will raise rates at its November meeting is 31%, according to the CME FedWatch Tool. There’s around a 45% probability priced in that rates could be a quarter-point higher coming out of the December meeting.

A bit lost in the market’s sell-off were the FOMC’s improved economic projections for this year and next. The FOMC raised its projections for 2023 and 2024 Gross Domestic Product (GDP) growth and lowered its projections for unemployment. It also reduced its forecast for 2023 core Personal Consumption Expenditure (PCE) prices growth to 3.7% from 3.9%.

What to watch
The Bank of Japan (BoJ) announces a rate decision tomorrow. Analysts expect no move, but the BoJ may be close to starting a rate-hike cycle. The BoJ rattled world markets in late July by easing its yield-curve control, a move that boosted the yen and caused a sharp upswing in U.S. Treasury note yields. The thinking was that if Japan’s rates rise, investors there might be more attracted to domestic debt and less likely to buy U.S. Treasuries. U.S. stocks fell on that BoJ decision and could be volatile tomorrow if the BoJ sends fresh hawkish vibes.

Two important reports—The Conference Board’s Leading Economic Index (LEI) and Existing Home Sales for August—are due out soon after the opening bell today.

Leading from behind: The LEI has fallen 16-consecutive months and today’s data isn’t expected to reverse that recession-signaling trend. Consensus is for a 0.5% monthly decline in August following a 0.4% drop in July, says Trading Economics. Still, The Conference Board’s coincident index, tracking where economic activity stands now, has grown slowly but inconsistently. Watch for any deterioration in current conditions and for any changes in the Conference Board’s outlook. Last time, it predicted a “short and shallow recession” in the Q4–Q1 period.

Existing Home Sales for August could provide insight into whether the shelter component of inflation is easing. Analysts see the headline 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. Existing home prices are underpinned by supply shortages, as many homeowners are reluctant to sell and take on higher mortgage rates.

Stocks in Spotlight
Falling prices for new homes tripped up shares of KB Home (KBH) in premarket trading despite the homebuilder beating analysts’ earnings and revenue expectations. The average selling price for KBH fell 8% and margins took a hit, though net orders grew. This mirrors results from competitor Lennar (LEN) last week, which also saw housing prices decline amid higher interest rates.

Things were cheerier in premarket trading at FedEx (FDX), which delivered better-than-expected earnings results late Wednesday and saw shares climb 5%. Cost-cutting efforts helped the bottom line, and guidance was in the range of Wall Street’s estimates. The announcement of $1.5 billion in planned stock purchases might also have helped shares.

Darden Restaurants (DRI) dished up better-than-expected earnings, but shares fell as investors appeared disappointed by same-store sales, especially for the fine-dining segment. Weakness there could reflect diners pulling back on expensive restaurant meals.

There’s some mergers and acquisitions (M&A) news this morning as Cisco (CSCO) agreed to buy cybersecurity firm Splunk (SPLK) in a $28 billion deal.

Talking technicals: Today’s early slide puts the S&P 500® Index (SPX) potentially on the path toward a test of summer intraday lows just under 4,350. The mid-August closing low near 4,370 might be an area to watch for possible technical support.

Thinking cap
Ideas to mull as you trade or invest

More Fed Takeaways: In his press conference following the decision, Fed Chairman Jerome Powell emphasized that the Fed saw progress in recent inflation reports and is encouraged that the labor market cooled without the massive job losses often seen when rates rise. But he also stressed that the FOMC doesn’t necessarily consider its work finished. He vowed to move “carefully” with future rate decisions, noting that the FOMC now can make small or no moves based on data because it raised rates so quickly and dramatically a year ago. “Given the market has been wrong about the trajectory of policy several times this year, there should be less discussion about rate cuts and more analysis of whether incoming data are trending toward the Fed’s target,” says Schwab’s Kevin Gordon. “So far, that isn’t yet the case in the eyes of the Fed.”

Perspective time: If you’re fretting over the Fed’s projections or shaking your head about Powell’s press conference, remember that no single Fed meeting or economic report tells the full story for a market with plenty of twists and turns. “The whole theme for 2023 is that investors shouldn’t get ahead of themselves after every single data point,” Gordon says. “At least in the U.S., the market has been horribly wrong about Fed policy this year.” That was certainly the case earlier this year when the FOMC effectively vanquished investor hopes for any 2023 rate cuts and the market had to play catch-up. That’s why investors should avoid knee-jerk emotional reactions. If you’re thinking of a trade based on what you heard yesterday, pause and consider whether it advances your long-term goals.

Data hide and seek: The Fed already has a tough job, so imagine how much harder it would be without timely economic data. That scenario might not just be imagination if the government shuts down in early October. That could prevent timely release of critical figures like the Labor Department’s monthly Nonfarm Payrolls report and the Commerce Department’s inflation data. During a 2013 government shutdown, the employment report and other data were delayed, Bloomberg reported. Chances of a shutdown look increasingly likely, with aid to Ukraine among many sticking points. Congress hasn’t passed any of the 12 appropriations bills to keep the government funded starting October 1 when the new fiscal year begins. Lawmakers are struggling to reach consensus on a continuing resolution to keep the doors open beyond that date, though talks will continue into next week. The first report possibly affected by a shutdown would be the October 3 Job Openings and Labor Turnover Survey (JOLTS), followed by the October 6 Nonfarm Payrolls report. Both are considered essential for tracking wages, labor demand, hiring trends, and the health of specific industries. The Fed next meets October 31–November 1

Calendar

• 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).
• Sept. 28: Q2 Gross Domestic Product (GDP)-third estimate, August Pending Home Sales, and expected earnings from CarMax (KMX) and Nike (NKE).
• TD Ameritrade® commentary for educational purposes only. Member SIPC.