Stocks sailed higher yesterday despite hawk squawk from Fed Head, a day earlier. Bond yields hit a pandemic era high, but a flattening yield curve shows that bond traders are on edge over the potential for a Fed policy error.
Don’t tell me what to do!! What’s all the rage about anyway? The Fed is raising the Fed Funds rate? Let’s remember what the Fed Funds rate actually is. It is the overnight lending rate charged between banks. Ok, let that soak in for a second… read it again if you are unsure. YOU cannot borrow anything at that rate, nor could YOU, OR WOULD YOU, lend anything at that rate. It is a bank thing, really! The money that we borrow in our day to day lives from credit cards, mortgages, auto loans, etc. are set by the companies who do the lending. Don’t believe me? Just look at mortgage rates. The national average for a 30-year fixed mortgage is now 4.52%. Mortgage rates hit a low of around 2.8% in February of last year. The Fed Funds rate was pegged at 0% by the Fed back in March of 2020 as the pandemic hit. Wouldn’t you know it, mortgage rates in April and June were right around 3.5%, only slightly lower than the pre-pandemic 3.75%. It took almost a year for Mortgage rates to hit their lows thereafter. Why? Because those rates are determined by the market…DEMAND. Sure, the banks can set them anywhere they like, but if consumers are unwilling to borrow at those rates, banks would be unable to make loans.
Turn the clock forward to 2021, late in the year, when Chairman Powell first mentioned that rate hikes may be appropriate. Mortgage rates did not even budge for the entire 4th quarter, closing out the year at around 3.18%. Now the Fed is really serious about raising the Fed Funds rate. It has actually already raised it by +25 basis points just last week and it expects to raise it several more times this year bringing it to around 2% just in time for Christmas. The Fed Chairman even noted that the FOMC may get to that target before Christmas by hiking in +50 basis point intervals. All of that happened between March 16th and Monday…3 market days. Mortgage rates, through that period, moved…not an inch. HOWEVER, they did run up quite quickly from January 1st through last week’s rate hike. The national average mortgage rate was around 3.25% at the beginning of the year and was around 4.5% after the Fed meeting. So, it is clear that the Fed’s hiking/easing/talking/whatever has very little correlation to what is perhaps, the largest loan most of us will ever undertake. The Fed is raising rates to discourage consumers from spending money, decreasing demand…in essence, making prices even HIGHER, so that we spend less. The lower demand and spending should…and certainly will cause prices to go down. But still, we just found out that it is not even the Fed that directly impacts rates that consumers actually pay. So, what are those rates correlated with? Well, if you look at 10-year Treasury Note yields, it is clear that mortgage rates appear to move almost in lock step with them. Ready for this? Who controls 10-year Treasury Note yields? Wait for it…bond traders and investors...the market. Yields go higher when traders expect a strong economy in the future. So, if things are looking up, yields go higher, along with consumer borrowing costs. Makes sense. If things are going well, consumers can afford the higher costs.
We have just been covering the cost of borrowing, which is a market unto itself. Mortgage rates going higher is, indeed, also a form of inflation. More demand for them pushes prices, or rates, higher. We don’t have to spend too much time talking about inflation of goods price inflation. We have all been experiencing that. In that world, 2 things will change the course of inflation. 1) Prices get so high that consumers simply stop buying things, forcing sellers to lower prices, or 2) a recession occurs because the Fed raises rates too high, forcing banks to pull back on their lending due to lack of liquidity, unemployment picks up, confidence falls, and consumers stop buying at any price, forcing sellers to ultimately, lower prices. So, my friends, unfortunately the burden of inflation is on us. The Fed will do what it will do, but it can only impact #2 above, while we have the power to impact #1. I would very much prefer that.
WHAT’S SHAKIN’
Adobe Inc. (ADBE) shares are lower by -2.67% after it announced that it narrowly beat EPS and Sales estimates by +0.72% and +0.49% respectively. While the company exceeded estimates it offered Q2 EPS guidance that was below analysts’ expectations. In the past 30 days, 76% of analysts have revised their price targets, 0 up, 23 down, 6 unchanged, and 1 dropped. Potential average analyst target price upside: +23.7%.
Carnival Corp (CCL) shares are lower by -1.22% in the premarket after it announced yesterday that it missed EPS and Revenue estimates by -34.40% and -27.43% respectively. The company, in addition to suffering decreased demand as a result of the pandemic is under pressure from higher fuel prices making future earnings somewhat uncertain. Potential average analyst target price upside: +19.7%.
General Mills Inc (GIS) shares are higher by +2.90% in the premarket after it announced that it beat EPS estimates by +7.53% on a -0.24% miss on Revenues. The maker of Cheerios upped its full year EPS forecast, citing the consumer price hikes. We should not be surprised to hear that. Dividend 3.25%. Potential average analyst target price upside: +4.5%.
YESTERDAY’S MARKETS
Stocks vaulted higher yesterday as investors continued to buy the dip despite much hawk-speak in the Fed community. The S&P500 rose by +1.13%, the Dow Jones Industrial Average climbed by +0.74%, the Nasdaq Composite Index gained +1.95%, the Russell 2000 Index added +1.08%, and the S&P500 ESG Index advanced by +1.17%. Bonds pulled back and 10-year Treasury Note Yields gained +10 basis points to 2.38%, a pandemic-era high. Cryptos climbed by +3.19% and Ethereum gained +3.15%.
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