Stocks suffered further setbacks yesterday as investors are all coming to the reality that killing inflation will be a painful process. Good news was bad news with yesterday's release of resilient economic numbers.
Next day delivery. Bear with me. I know that it’s Friday, and I promise you, I DO try to keep Friday’s note on the lighter side, but after this tumultuous week for stocks and bonds, I feel as if I owe you an explanation. I will keep it simple by reducing it to two charts.
The first chart should not come as a surprise to you. It is a plot of implied Fed Funds rates, based on futures. This is quite literally the first bit of data that I look at every morning… at 4:00 AM… WHILE YOU ARE MOST LIKELY SLEEPING. This morning’s numbers give a 100% probability of a +75 basis-point hike in next week’s FOMC meeting. There is a 27% chance that the Central Bankers will hike a full percentage point. In November, the FOMC will meet once again, and futures are predicting another +75 basis-point hike. According to those same tea leaves, the Fed will give us an early holiday gift of another +25 basis-point hike with a 67% chance of a +50 basis-point hike. That is a lot of heavy lifting… er, hiking for our inflation fighting heroes in Washington DC, especially over a 3-month period. Remember, the Fed hasn’t told us any of this but rather, these predictions are based on where traders have placed their collective bets in the futures markets, which tend to be quite accurate. What is important to note here is that those numbers have been going up steadily over the last week, largely in response to the larger than expected jump in CPI. The collective markets now expect the Fed to remain aggressive, quashing the hopes of those few remaining holdouts that believe that the Fed will back down. Where does that leave rates by the end of the year? At around 4.25%. On September 1st, predictions were for a Fed Funds rate of 3.75%, so somewhere over the past 2 weeks markets have factored in another ½ percentage point. That has caused both bonds, which are directly impacted by interest rate expectations, and growth stocks, which are indirectly but most definitely impacted by interest rates, to fall.
From this chart, you can see the steep upward path of expected rates between now and year end, which has caused havoc to interest-rate sensitive stocks. You will also note, that while rates continue to climb into 2023, traders are expecting the gains to be smaller and ultimately top off somewhere in late spring. This is THE driver of all markets at the moment. However, there is something else vexing markets, and that is the US Dollar. Though the US Dollar has far less influence on the markets than expected Fed Funds and inflation, it has been an on-and-off factor over the past few weeks. Check out chart #2 which details the Dollar Index, which sets the dollar against a basket of trade-partner currencies. The actual number is not as important as how the Dollar Index grew over the past year. A strong dollar is good for US travelers abroad as foreign goods and services are cheaper due to currency conversion. But unfortunately, the reverse is true for US companies that sell goods outside the US. A strong dollar means that US produced goods are more costly… ON TOP OF ALREADY high prices. This will serve to lessen demand for US dollar-denominated goods and strain corporate earnings, ALSO A STRAIN ON STOCKS. This rocket ride is set to continue as long as interest rate expectations continue to climb. The simple reason is that higher bond yields in the US draw foreign investors who must convert their sovereign currencies to $US in order to buy the higher yielding US bonds. The conversion is equivalent to buying dollars and selling local currency, thus driving the dollar higher… increasing the strain on corporations… and their stocks.
I will leave you with one bonus chart. This is a price chart of FedEx over the past 60 days, including today’s premarket. You will notice that shares are down by some -21% from last night’s close. That is due to the company’s announcing preliminary earnings for the current quarter that missed estimates by quite a bit. The company further pulled its full year forecast as it struggles to make sense of the poor showing. The company said that conditions in the current quarter were far worse than initially expected, especially with regard to foreign shipments in the EU. Why have I singled out FedEx? Because it can be viewed as a signal that the economy is, indeed, slowing down in response to the already-aggressive Fed. Will the Fed take note of FedEx’s revelation? Absolutely. Will it change its tightening response? I’ll let you be the judge of that.
YESTERDAY’S MARKETS
Stocks gave up further ground yesterday in response to positive economic numbers. Good economics was bad for stocks yesterday. A resilient economy means that the Fed will have to possibly mash even harder on the brakes. The S&P500 slipped by -1.13%, the Dow Jones Industrial Average declined by -0.56%, the Nasdaq Composite Index traded lower by -1.43%, and the Russell 2000 Index traded lower by -0.72%. Bonds fell and 10-year Treasury Note yields climbed by +4 basis points to 3.44%. Cryptos lost -2.77% and Bitcoin gave up -0.47%.
NXT UP