Stocks rallied yesterday after bond yields yielded for the day, allowing recently shunned tech shares to lead the broader markets higher. A broad reaching Fed report relayed that economic growth is flat and that prices have moderated moderately – is the Fed’s medicine working?
Dress rehearsal. Well, each day we get closer and closer to THAT day. A day which we have been discussing for some time, all of us. Later this month, a little less than 2 weeks from now, the Fed will announce its rate decision for the upcoming September FOMC meeting. Why is this meeting so important? Because it is generally accepted that the Fed will come out strong in this meeting and then sit back and see what comes of things… those being inflation and the health of the economy. At this point the Fed has very little choice but to enact a larger rate hike for several reasons. Foremost, the Fed must maintain its credibility as an inflation fighter. It has essentially told the markets in so many ways that this month will be a big one; big meaning at least ½ a percentage point. Any less would tarnish its image and lessen the impact of one of the Fed’s most important policy tools: forward guidance. Despite recent evidence of receding inflation, sky-high prices are still prevalent. Sure, the CPI fell to +8.5% from +9.1%, but +8.5% inflation is still in the nosebleed section. Additionally, the labor market is still tight and continuing to drive price gains. Last week’s employment numbers appeared soft, but they are still right above 6-decade lows. Similarly, job vacancies, according to the latest JOLTS Job Openings release, are also just below record highs. Lastly, the current Fed Funds target of 2.5% is considered to be the neutral rate, meaning that it is not expected to be restrictive, according to most economists. Anything beyond will likely have a greater impact on economic growth. Ok, so you get the message. The Fed is going to raise interest rates.
According to the latest readings from Fed Funds Futures, markets are expecting at least a +50 basis-point hike with an 82% chance of a +75 basis-point escalation. If you have been following these probabilities, you will note that they go up and down, but more recently, they have been creeping up. Yesterday, the Wall Street Journal reported that signs indicate that the Fed will, indeed, hike rates by +75 basis points, a prediction seconded by at least one prominent bulge bracket investment bank overnight, WHILE YOU SLEPT. The Fed governor speaking circuit has been on fire these past 2 weeks as we come up to the pre-meeting blackout period. The general message line being toed by speakers is that they will be tough and will not let up until inflation gets back to the Fed’s +2% target. Yesterday, Vice Chair Lael Brainard sent a subtle message of hope to the market. She said that the Fed would not let up until there were several months of data pointing to a path back to the target rate. The optimistic interpretation of the overture is that the Fed will stop hiking if we get a few, perhaps 3 months of promising data. That still leaves investors wondering what will happen on the 21st.
Today’s central bank events may give us a clue. The Federal Reserve’s overseas cousin the European Central Bank (ECB), will announce its rate policy today. Looking at futures for the ECB’s key lending rate we see a somewhat similar picture to Fed Funds. They predict a +50 basis-point hike with a 74% chance of a +75 basis-point jump. Now, the EU faces very different challenges than the US. Inflation in the EU is confounded by the war in Ukraine which has spun off an energy supply challenge coming into Europe’s peak demand season: winter. That being said, Fed watchers will be watching the ECB and if it fires a +75 basis-point salvo, the probability of the Fed raising that extra ¼ percentage point is likely to go up. Fed watchers will also be watching recently outspoken Fed Chair Jerome Powell who will speak today. Will he back off the tough Jackson Hole rhetoric or will he double down? That speech takes place this morning around 9:10 AM Wall Street Time. This will be the last time the Chair speaks before the next FOMC meeting and it will be his final opportunity to jawbone the markets. It is important to recognize, however, that nothing is set in stone. Next Tuesday we will get another CPI read which is currently expected to show a further decline in inflation. If we go by Vice Chair Brainard’s implication, that would be 2 down and 1 to go. Next month’s CPI read will be on October 13th, a few weeks prior to the November 2nd FOMC meeting. Will it meet Brainard’s standards for a trend if it declines for a third straight month? According to futures, the odds are in favor of Fed Funds being at 3.5%, a full percentage point higher that today’s target. We can get there with a +75 basis-point bump this month and a +25 basis-point bump in November, which is likely to be favored by the markets. Let’s see how the rehearsal unfolds today.
YESTERDAY’S MARKETS
Stocks rallied yesterday as traders were relieved that bond yields eased off Tuesday’s highs. The S&P500 gained +1.83%, the Dow Jones Industrial Average rose by +1.40%, the Nasdaq Composite Index advanced by +2.14%, and the Russell 2000 Index gained +2.21%. Bonds rose and 10-year Treasury Note yields pulled back by -8 basis points to 3.26%. Cryptos added +0.82% while Bitcoin climbed by +2.15%.
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