Stocks have no fear of rate hikes

Stocks rose in yesterday’s session as the Fed ripped the Band-Aid off by raising interest rates.  Retail Sales remain healthy, growing by +0.3% last month and an upward revised +4.9% in January.

Take a hike!  If it looks like a hawk, screeches like a hawk, and flies like a hawk, then it’s probably a hawk. The Fed has been doing a lot of screeching and flying over the past several months, and yesterday the Bank finally revealed itself, officially, as being hawkish. After two days of deliberation, the FOMC announced that it was raising the Fed Funds rate by ¼ of a percentage point (+25 basis points), which was largely expected. The Fed has further made it clear that it is no longer focusing on accommodative policy, which means that it is solely focused on tamping down inflation, and far less concerned about stimulating the economy.

Along with yesterday's policy announcement came members’ economic forecasts. Members project that GDP will grow by a median of +2.8%, which is notably lower than the +4.0% growth predicted in its December release. For the record, a +2.8% growth would be considered quite solid by historical standards. The downward growth revision should not be surprising given the growth headwinds from elevated energy costs, the Ukraine war, and elevated inflation. The Fed, on median, believes that GDP will grow at +2.2% next year, and by +2.0% in 2024. The declining trend is consistent with the Fed’s objective to slow demand slightly, to allow inflation to cool down. These numbers also show that the Fed is not projecting any recessions in the next few years. In the Chairman’s press conference, he stated that there was a very low probability of recession. He further stated that the economy was quite strong and could easily take the current and upcoming rates hikes.

Also notable in yesterday's release was the Fed’s median projection of +4.3% PCE inflation by yearend. December’s projection was for +2.6% inflation for 2022. Powell explained that the upward revision was due to the economic side effects of the war in Ukraine. Inflation next year is expected to drop to a more comfortable +2.7% while the 2024 projection has it at +2.3%. On the Fed’s other mandate, unemployment, the committee expects that rate to remain relatively stable this year and next (3.5%) and to tick up slightly (3.6%) in 2024. Chairman Powell commented that the labor market was tight “to an unhealthy level.” I have covered this in numerous notes as it is also a principal driver of inflation.  Tight labor markets lead to rising labor costs, and ultimately, higher prices to consumers.

Finally, there was the FOMC Dot Plot which shows FOMC member projections for interest rates in the future. Those projections are important as they are made by the people who create the policy. Of course, they are not set in stone, but as of yesterday’s meeting, the dot plot shows that the FOMC believes, on median, that the Fed Funds rate will rise to 1.91% by the end of the year. That would mean 6 more +25 basis point hikes, and is completely in line with expectations, based on Fed Funds futures. The Dot Plot further reveals that the FOMC expects Fed Funds to increase to 2.73 next year, implying 2 to 3 additional 1/4-point bumps next year. Interestingly, the committee expects rates to remain the same in 2024 but to recede to 2.4% beyond. That last number has raised some eyebrows as the Fed typically only lowers rates when it is trying to stimulate the economy. Investors may wonder if the Fed expects rough waters beyond 2024.

The market reaction to the Fed release was to initially stall the earlier rally in stocks but to ultimately rally strongly into the close. Rate hikes are rarely viewed as being positive for the market, so the rally was most likely due to the fact that everything was in line with expectations. In other words: no negative surprises. The bond market had a different reaction altogether. On the front end of the yield curve, 2-year notes fell pushing yields +9 basis points higher. Longer tenor 10-year notes also fell pushing yields higher by +4 basis points. When shorter maturity yields move up faster than longer ones, the yield curve flattens, which typically occurs ahead of a recession. In fact, that part of the yield curve has been flattening since late last year and it is currently flatter than it has been in the past 2 years. This can be interpreted as the bond market factoring in rough economic seas ahead. If bond traders are right, it wouldn’t be the first time that the Fed’s aggressive inflation fighting policy would cause a recession… nor would it be the last.

YESTERDAY’S MARKETS

Stocks rallied yesterday as talks between Ukraine and Russia appeared to be productive and the Fed release coming in as expected. The S&P500 gained +2.24%, the Dow Jones Industrial Average climbed by +1.55%, the Nasdaq Composite Index jumped by +3.77%, the Russell 2000 Index advanced by +3.14%, and the S&P500 ESG Index added +2.30%. Bonds gained ground and 10-year Treasury Note yields gained +4 basis points to 2.18%. Cryptos rallied by +2.90% and Bitcoin traded higher by 4.61%.

NXT UP

• Housing Starts (Feb) may have climbed by +3.8% after falling by -4.1% in January.
• Building Permits (Feb) are expected to have pulled back by -2.4% after rising by +0.5% in the prior release.
• Philadelphia Fed Business Outlook (March) is expected to have fallen to 14.8 from 16.0.
• Initial Jobless Claims (March 12) is expected to come in at 220k, lower than last week’s 227k claims.
• Industrial Production (Feb) may have grown by +0.5% after expanding by +1.4% in January.
• FedEx and GameStop will release earnings after the closing bell.