And now… we wait for interest rate policy

Stocks rallied on Friday for a weekly gain, not experienced for the prior 3 weeks. Rising Treasury yields slowed their ascent allowing risk assets some breathing room to cross over key technical levels, aiding in Friday’s rally.

Are we there yet? Not sure, but it is highly likely that I have used this very same tagline in the past few years. Not once, but more likely several times, a solid indicator that markets have been quite challenging since we were sent into a tailspin from the pandemic lockdowns only to rise like a fiery phoenix which was quickly extinguished once record inflation emerged for the first time since the 1980s. That just about sums it up. So here we are, in the midst of the pitch battle with inflation having deployed our most powerful weapon The Federal Reserve against our foe, inflation. It is an ugly battle, for sure, and the smoke has not yet cleared from the battlefield, leaving us all in the dark as to who will emerge the victor, when the fight will end, and what will be the collateral damage.

Until the smoke clears… or until the Fed itself tells us that the job is done, all we can do is speculate on the outcome. As things stand today, we know that the battle rages on and that the Fed is planning a sizable offensive next week when its war ministers (the FOMC) meet to decide on interest rate policy. Until a few weeks ago, a large +50 basis-point salvo was the best bet, but probabilities for a much larger +75 basis-point assault have increased. Fed Funds futures predict a 90% chance of it, and if you understand probabilities at even a high level, you know that those odds are really high. You see, the Fed is eager not to jolt the financial markets, and it appears that the markets have given it the-all clear, so the Fed is likely to take advantage of it and press into what it has recognized as the restrictive zone, where most economists agree interest rates will have a slowing effect on the economy. Whether you agree with those economists or not you certainly know that the Fed’s offensive is already having an impact on how consumers behave, and consumers play a big role in tamping down inflation. We just have to be jolted into demanding less, forcing suppliers to cut costs.

One obvious influence of higher interest rates is the housing market, which is directly impacted by mortgage rates. If you already own a house but have financed it with a variable mortgage, your next adjustment cycle will most likely result in your having to make bigger payments as your base rate adjusts higher. I saw a very interesting statistic this morning that showed that, in the US, only 7% of mortgages over the past 5-year period were variable, so it is reasonable to assume that rising interest rates will have little impact on folks who have already locked in lower fixed rate mortgages. Higher rates will, however, have a more direct impact on new/existing home sales as 30-year fixed rate mortgage rates have risen over 6% for the first time since 2008. Higher monthly payments mean hopeful buyers can afford to pay less for a new home. Lower demand has already shown signs of impacting frothy home prices in the latest wave of housing numbers. This will, of course, have reverberations throughout the entire housing industry, from homebuilders to raw materials.

Another near-term impact on consumption will be consumer credit. If buyers rely on credit cards to make purchases, or worse yet, if they are carrying big credit balances on their cards, those monthly payments are going to be higher. Average APR for credit cards is currently around 21% and on the rise. Last year, those rates were closer to 15%, depending on what data you use! That will certainly take a bite out of household discretionary spending for those households which carry big credit card balances. Those higher rates may also prove daunting for those consumers thinking about making big purchases using credits cards.

What this all amounts to on the Fed’s overall progress in its pitch battle with inflation is still unclear, but we will get some intelligence on its progress in the form of Consumer Price Index / CPI tomorrow. Prices are expected to have eased slightly for the month, but most of the pullback may have come from recently declining energy prices, which have little to do with the Fed’s rate hiking. Retail Sales figures, later this week, will show us if consumers are pulling back, or at least, not increasing their spending (as expected). Still, the battle rages on. The Fed is in a press blackout period leading up to next week’s meeting, so no more scary messaging from the inflation fighting warriors until the commander of the forces, Chairman Powell, gives his presser next Wednesday. Stay tuned and stay focused.

Friday’s Markets

Stocks rallied on Friday after markets breached key technical levels and rising yields slowed their ascent. The S&P500 Index climbed by +1.53%, the Dow Jones Industrial Average rose by +1.19%, the Nasdaq Composite Index jumped by +2.11%, and the Russell 2000 Index gained +1.95%. Bonds slipped and 10-year Treasury Note yields lost -1 basis point to 3.30%. Cryptos climbed by +6.65% and Bitcoin advanced by +0.91%.

NXT UP

• Today is a quiet day for the numbers but things will heat up tomorrow with closely watched Consumer Price Index. Later in the week we will get the Producer Price Index, Retail Sales, weekly employment numbers, and University of Michigan Sentiment. Refer to the attached economic calendar for times and release details.