Stocks pulled off a rally yesterday as traders bought the dip, displaying confidence that the Fed has no negative surprises up its sleeve. Strong earnings are boosting stocks, a sign that investors perceive value.
A long time ago in a Fed meeting far far away…. [cue theme song] I really want to write about earnings season, which should be of critical importance, but the reality is that the Fed is going to announce its policy later today…a force that cannot be avoided. Let’s just get it out there. The Fed is almost certainly going to raise its key lending rate by at least +50 basis points today. “Is that a big deal,” you wonder? Well, considering the last time the Fed raised rates more than +25 basis points to Y2K, a long time ago. That’s over 2 decades ago, if you’re counting. The usually cautious Fed’s willingness to even consider the maneuver demonstrates its commitment to tamping down inflation. So, what does that mean for the markets? The answer is simple…not really, as nothing is simple with markets. But the simplest answer is that the markets have already priced in the aggressive hike. Further, the market is pricing in a high probability of another +50 basis point hike in June, followed by a series of hikes that will bring rates to 3% or higher by the end of the year. That seems utterly mad considering that we have not seen the Fed Funds rate over 3% since January of 2008, the start of The Great Recession. However, despite this madness, it is important to realize that the market is expecting the move. What’s more is that a year ago, very few would believe that we would see Fed Funds greater than 0%, much less at 3%. The reality is, however, that we are here now and that the market has priced the moves in. To be clear, those rates are highly probable, but not guaranteed. Further, we have very little visibility into exactly what combination of hikes and pauses will get us to those levels by December. What that means is that volatility around those Fed decisions is likely to remain high.
The Fed is also expected to announce plans to reduce its oversized balance sheet which doubled in the pandemic. Known in economic circles as Quantitative Tightening, or QT, the policy involves the Fed’s selling of bonds in the open market. The goal of QT is twofold: free up cash and cause bond yields to rise. When yields rise, borrowing costs for you, me, and corporations go higher. The hope is that those higher costs will cause us to spend less and allow prices to moderate. In fact, those costs have already risen, despite the Fed having done very little to date. Mortgage rates have climbed to 5.5% from just over 3% in the past year, much of the gains having been made since January. Treasury Notes maturing in 10 years have seen yields nearly double in the past 5 months alone. As corporate borrowing is directly linked to Treasury yields, those borrowing costs too, have doubled. All these are signs that the aggressive Fed is already factored in the market.
That leaves us with a few questions to ponder. Will all those higher yields and rates bring inflation back to the ground, especially considering inflation is also caused by supply chain issues which are not directly affected by interest rates? Another looming question is whether the Fed will get yet more aggressive than the market is expecting? Finally, will the Fed’s hawkish activity cause the economy to fall into a recession? Unfortunately, the answers to those questions will not be answered in the short-term. That means more volatility for stocks for the near-term. For today, it is highly unlikely that there will be even a trace of dovish language, as the Fed, already behind the curve, would not want to risk the gains gotten through its jawboning activities. There is some probability that the Fed may announce a +75 basis point hike (market is predicting a 3% probability of that). The Fed may announce its intent to raise by +75 basis points in June. Markets gauge the possibility of a +50 basis point hike at 91% for June with a 9% chance of a +75 basis point hike. If the Fed sticks to the plan as the market expects it, we could see some potential upside for beaten down stocks. It is not likely to be without volatility, given so much uncertainty and that there is still the downside possibility that the Fed surprises the market with more aggressive tightening. The FOMC will announce its decision this afternoon at 2:00 PM Wall Street time. The press conference that follows will no-doubt, be watched very closely for clues or hints to help us answer those looming questions.
WHAT’S SHAKIN’
Johnson Controls International plc (JCI) shares are lower by -9.22% in the pre-market after the HVAC tech company announced that it missed EPS and Revenue estimates by -0.15% and -1.07% respectively. The company lowered its current quarter and full-year forward guidance, citing supply chain headwinds as the cause of its woes. Dividend yield: 2.66%. Potential average analyst target upside: +27.7%.
Moderna Inc (MRNA) shares are higher by +8.16% in the pre-market after it announced a blowout quarter, beating EPS and Revenue estimates by +7.19% and +28.78% respectively. The stock is down by -42.3% year to date. Potential average analyst target upside: +50.4%.
ALSO, THIS MORNING: Generac Holdings (GNRC), CVS Health (CVS), Regeneron (REGN), Emerson Electric (EMR), Lumentum (LITE), IDEXX Labs (IDXX), Horizon Therapeutics (HZNP), CDW (CDW), and UBER (UBER) all beat on EPS and Sales, while Wingstop (WING) and Yum! Brands (YUM)missed on EPS and Revenues.
YESTERDAY’S MARKETS
Stocks logged gains yesterday as markets grew comfortable with the Fed rate decision, expected today. The S&P500 rose by +0.48%, the Dow Jones Industrial Average climbed by +0.20%, the Nasdaq Composite Index traded higher by +0.22%, the Russell 2000 Index jumped by +0.85%. Bonds rose and 10-year Treasury Note Yields slipped by -1 basis point to 2.95%. Cryptos gave up -2.14% and Bitcoin traded lower by -1.38%.
NXT UP