Stocks had a mixed close yesterday as investors continued to adjust their views on inflation and the Fed’s ongoing response. Manufacturing continues to contract as consumers shift to services from goods.
Adjusting. What a difference a few weeks makes. 2023 jumped off the starting line with a hearty sprint. Traders were eager to reset their sights after a year of painful drawdowns in which selling pressure was relentless. The Fed sent a subtle signal with its +50 basis-point hike at the end of the year. That was preceded by a series of +75 basis-point bumps, so the “lighter” addition perhaps meant the Fed was close to the end of its hiking cycle. Way back in the olden days… A YEAR AGO, economists were all generally settled on 3% as the r* (r-star) rate. That is the level at which interest rates were neither stimulative nor restrictive, let’s call it neutral. Now, that number has been hotly debated for many years, but as mentioned earlier, most economists, even the Fed often referenced 3%, or thereabouts, as the number. It is therefore quite logical to assume that a Fed Funds rate of 4.5%, which is where we ended up in 2022, would be sufficient at slowing the economy and allowing inflation to abate.
We all knew that inflation was still too high, but time and patience would allow that restrictive rate to take its toll. The US economy, after all, is not a sports car, but rather, more like a fully loaded container ship. Starting, stopping, and turning takes time… and lots of patience. Ok, granted. That was enough for the bulls to air their horns for the first time in many months, and the result of that was January’s gain in stocks… and bonds.
The Fed, however, was offering a different narrative. Something more like rates are not sufficiently restrictive yet and would therefore have to be hiked further and once there, be held there for longer. The message was clear as clear crystal and the economic numbers supported it. For some strange reason, the market didn’t get the message. In mid-January, Fed Funds futures were predicting 2 hikes of +25 basis points, reaching a terminal rate of just under 5% followed by 2 rate cuts which would bring Fed Funds back to where they started the year. Below is what that looked like, graphically. Keep reading to get the before and after effect.
Turn the clock forward just a few short weeks. Futures were correct in pricing in a +25 basis-point hike, but lots of Fed-speak and a few hot employment and inflation numbers later, and the view has changed somewhat… actually, quite a bit. Yield on the 2-year Treasury note, which is closely tied to Fed policy jumped in February from 4.10% to 4.81%. That is a big move for a 2-year note, and it is largely due to reset in rate expectations in response to the economic numbers. If we plot the same chart of Fed Funds futures from above, but with today’s pricing, it looks quite different. Now, futures are predicting 3 to 4 hikes of +25 basis points before reaching a terminal rate north of 5.4%, with the slight possibility of cuts before closing the year out somewhere around 5.5%. Stocks, which basked in the January sun of optimism got a stark reality check in February as the market finally got a memo from the Fed. Rates are going higher and they are likely to stay higher for longer, because inflation is still too high. The Fed is now following the numbers. If they keep coming in hot, we can expect this same chart to change further in the weeks ahead. On the bright side, rate hike expectations could also pull back, if the numbers begin to show progress.
WHAT’S SHAKIN’
Hormel Foods Corp (HRL) shares are lower by -3.49% in the premarket after the company announced that it missed EPS and Revenue estimates by -11.5% and -3.3% respectively. The company also provided full year guidance below analysts’ estimates citing not only supply chain pressures on profitability, but also lower sales volumes. Dividend yield: 2.50%. Potential average analyst target upside: +7.1%.
Tesla Inc (TSLA) shares are lower by -6.13% in the premarket after disappointing analysts at yesterday's investor day. Musk provided little detail on near term and longer-term plans for the company, which was a letdown after much hype leading up to the event. The company will announce its Q1 earnings next month. Potential average analyst target upside: +2.7%.
Salesforce Inc (CRM) shares are higher by +15.39% in the premarket after it announced that it beat EPS and Sales targets by +23.20% and +4.81% respectively. The company provided an upbeat outlook which included margin expansion. The company remains focused on eliminating costs and announced an increase in its stock buyback program. Potential average analyst target upside: +29.9%.
YESTERDAY’S MARKETS
Stocks had mixed close yesterday as investors continued to adjust year-end Fed Funds targets. The S&P500 fell by -0.47%, the Dow Jones Industrial Average climbed by +0.02%, the Nasdaq Composite Index declined by -0.66%, and the Russell 2000 Index gained +0.08%. Bonds fell and 10-year Treasury Note yields climbed by 7 basis points to 3.99%. Cryptos added +0.81% and Bitcoin climbed by +1.78%.
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