Way off, Target

Stocks fell yesterday on weak pre-market earnings data that suggested Americans are struggling with inflation – we knew that, but it was tough to see. The Fed wants to appear tough…with a softer side and investors are confused.

Bold with slight hints of dove. Sure, I would like for just one day to focus on something other than the Fed, interest rates, and inflation. But unfortunately, those are the three sentinels guarding the gates that lead to the bull markets of the days of yore. So, if there are any clues available on what those watchmen may do, it is in our best interest to analyze them carefully.

As, I am sure, that you are already aware, the Fed releases the minutes from its FOMC policy meetings several weeks after the meeting. Technically they are on the taxpayer payroll, so I suppose it is fair that the big bankers strive to be transparent in their endeavors. Though that sounds nice, that is not the reason that the Fed releases its meeting minutes. The minutes are a form of manipulation. Wow, the word “manipulation” has such a negative connotation, doesn’t it? However, it is true, and it is very much a part of Fed policy. We often hear that the Fed seeks to capture the hearts and minds of consumers. “Wait, where is this going Mark,” you ask?  If the Fed appears to be soft on inflation, consumers will just continue to consume like there is no tomorrow, fanning the flames of inflation. However, if the Fed appears to be taking a hard line on inflation, consumers will react by cutting back in anticipation of tightening monetary conditions, which should serve to keep inflation in check. So, credibility is important for the Fed. Though this is not necessarily a revelation, it is important to realize that manipulating consumers is no easy task. If the Fed pushes too hard it can cause a panic which could lead to consumers pulling back altogether. The result would not be limited to a recession. It could lead to runs on commodities, or worse yet, runs on the banking system, which would only exacerbate the problem. So, it is clear that the Fed must strike that perfect balance between credible inflation fighter and thoughtful custodian of the economy. Ultimately, the rubber meets the road in interest rate policy and open market operations, and where Fed talk is unable to effect behavioral changes, it certainly lessens the blow of any required, harsh policy moves. So, investors: eyes and ears open.

Back to the meeting minutes. Those are most often uneventful and filled with slightly more information about what we already know. The Fed Chairman typically fills in many of the grey areas in his post-meeting press conference. However, in these uncertain times, anything can happen, so it is incumbent on us, as investors to pay close attention to ANYTHING that comes out of the Federal Reserve. Yesterday afternoon, the Fed released the minutes from its July 27^th meeting. Here are the quick takeaways:

1. The Fed is committed to fighting inflation and is not going to let up.
2. The Fed feels that it is appropriate to move its key lending rate into a restrictive area to tamp down inflation. Remember, though the Fed has been hiking aggressively to get Fed Funds to its current 2.5% level, it considers this level to be neutral and non-restrictive.
3. The Fed feels that it may be appropriate to slow or even stop hiking at some point.
4. The Fed believes that the full effects of the hikes to date have not yet propagated through the economy. In other words, it believes that the hikes will have a delayed effect.

Now that I have reduced the copious notes into those 4 points. In response to those, I would say:

1. We knew that
2. We expect that
3. This is new…a subtle hint of benevolence
4. This is somewhat new. Powell said something similar in his post policy meeting presser. This supports the theory that the Fed would consider a pause and wait for the prior hikes to take effect.

What does that really all mean for the markets? Let’s start with the market’s built-in expectations, based on Fed Funds futures. Futures are predicting a +50 basis-point hike next month. That would put rates in the “restrictive” zone. Futures are predicting that Fed Funds will be at 3.5% by year end. With 2 meetings to go after September, the Fed would only need to hike another 50 basis points to get there. THOSE potential hikes are the ones that the Fed will most likely exercise its optionality on to either slow down or stop. Don’t get too excited. Futures don’t expect any rate CUTS until the second quarter of 2023. Of course, the Fed will act in a data-dependent fashion and modify its policy accordingly. For example, if inflation pulls back in the months ahead, the Fed is more likely to slow down the hiking regimen…or vice versa. Similarly, if economic or labor conditions worsen. Finally, it is important to recognize that these minutes were memorialized before the most recent CPI number which showed a decrease in inflation. Those notes were also written prior to the super-hot employment number from a few weeks ago. There is no telling what the Fed might be thinking today. Right now, Fed speakers are keen on underscoring point 1 from above, and we know why. The rubber will meet the road on September 22^nd after the next FOMC meeting and there are plenty economic numbers to contemplate between now and then.

YESTERDAY’S MARKETS

Stocks closed lower yesterday after bad results from Target weighed on equities. Softer than expected Fed Minutes were not soft enough to pull stocks into the green. The S&P500 fell by -0.72%, the Dow Jones Industrial Average traded lower by -0.50%, the Nasdaq Composite Index dropped by -1.25%, and the Russell 2000 Index declined by -1.64%. Bonds traded off and 10-year Treasury Note yields gained +9 basis points to 2.89%. Cryptos fell by -2.90% and Bitcoin declined by -2.40%.

NXT UP

1. Initial Jobless Claims (August 13) is expected to come in at 264k, slightly higher than last week’s 262k claims.
2. Philadelphia Fed Business Outlook (August) is expected to be -5.0 after a -12.3 print in July.
3. Existing Home Sales (July) may have declined by -4.9% after falling by -5.4% in June.
4. Leading Economic Index (July) is expected to have declined by -0.5% after pulling back by -0.8% in the prior month.