Throwing in the Powell: Fed Chair Helps Spark Inflation, Rate Hike Fears

New Fed Chair Jerome Powell appeared to spark inflation and rate hike fears in his testimony to Congress Tuesday, helping lead to a 1% market drop.

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 (Wednesday Market Open) Welcome to Wall Street, Chairman Jerome Powell.

After two days of roaring stock market gains and falling yields, Powell appeared to re-ignite investors’ inflation concerns Tuesday, helping send stocks into a 1% tailspin. In his first testimony to Congress as Fed boss, Powell voiced optimism about the economy and expressed faith that inflation could hit the Fed’s target. Yields in the interest rate complex jumped even as he spoke, and stocks turned red.

By early Wednesday, pre-market trading turned higher despite falling markets in Europe and Asia, and bond yields moved a little lower. 

Key data hit the Street this morning, as the government issued its second estimate for Q4 gross domestic product (GDP) growth. The government now sees Q4 growth at 2.5%, in line with Wall Street analysts’ estimates and down a bit after the previous two quarters saw growth of 3% or more. No surprises here, and perhaps that could ease some fears about the possibility of an over-heating economy. 

Still, Powell’s comments might continue to reverberate through the market today.

"At the December meeting the median participant called for three rate increases in 2018," Powell said Tuesday during his testimony to the House Financial Services Committee. "Since then, what we've seen is incoming data that suggests a strengthening in the economy and continuing strength in the labor market. We've seen some data that in my case will add some confidence to my view that inflation is moving up to target. We've also seen continued strength around the globe. And we've seen fiscal policy become more stimulative."

It was arguably those words that sent stocks spinning lower after prices initially climbed during the early minutes of Powell’s testimony. The 10-year Treasury yield, which had traded as low as 2.85% soon after the opening bell, climbed to a peak of 2.93% intraday before ending the day near 2.9%. Perhaps more ominously, odds of a fourth Fed rate hike this year rose above 30%, according to the futures market, while chances for a rate hike by next month’s meeting stayed locked in above 87%. See figure 1 below.

As the year started, the Fed had been hinting at three rate hikes in 2018, but Powell’s remarks about “strengthening in the economy” since December appeared to lead many market participants to expect a more hawkish Fed stance in the months to come. The possibility of a fourth hike might be what’s spooking some investors.

Powell’s statement about “inflation moving up to target” also might have played into the market’s tumble. Though inflation as measured by Personal Consumption Expenditures (PCE) prices was a tepid 1.7% in 2017, last month’s reported 2.9% rise in personal wages helped lead to fears of rising prices and arguably played a major role in the market’s early-February correction. Investors get a look at January PCE data early Thursday, and any signs of inflation there could cause more nervous reaction.

What might be getting lost here in the market’s kind of reflexive dive is the fact that Powell’s words were optimistic. He seems to like what he’s seeing in the economy, and in the long run, good news for the economy tends to mean more consumer spending and perhaps better earnings results for companies. At this point, the market appears highly sensitive to rising yields and the possibility of additional rate hikes, but borrowing costs remain low from a historic sense. It’s important for investors to keep that in mind, but still be wary in these volatile times.

Speaking of volatile, the VIX jumped back in a big way Tuesday, climbing more than 18% by the end of the day to nearly 19. That was quite a turn-around, considering VIX had been easing over the last few sessions after spiking earlier this month.

From a sector basis, some of the worst performers Tuesday included the more rate-sensitive areas of the market, including telecom and utilities. But consumer discretionary also fell more than 2%, despite strong earnings from Macy’s (M). More department stores report later this week.

More earnings rolled into town early Wednesday, including disappointing results from Lowe’s (LOW). Shares fell sharply in pre-market trading after the company fell short of Wall Street analysts’ expectations. This came after strong results from rival Home Depot (HD) earlier in the earnings season. The interesting thing is that both LOW and HD lowered their full-year expectations. This could be bullish for the home market, meaning people might be stepping up to buy new homes rather than re-modeling the ones they’re in. Or it could be a bearish sign that the home market and consumer spending on home repair and re-modeling in general might be facing some trouble.

Another earnings report getting some attention early Wedensday comes from Etsy (ETSY), shares of which leaped in pre-market trading after the company beat Wall Street analysts’ estimates. ETSY delivered its first quarter ever of $1 billion in general merchandising sales, the company said in a press release.

It’s the last day of the month, so extra vigilance might be warranted (see below). Also, unless there’s an incredible rally today, it looks like the major indices are all likely to close with slight losses for February.

SPX versus TNX, Feb 27, 2017

FIGURE 1: POWELL COMMENTS SPARK RATE MOVE.

The exact moment when the markets changed course is made clear from the above chart, which plots the S&P 500 (SPX) against the Ten-Year Treasury Index (TNX). Data sources: S&P Dow Jones Indices, Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Next Episode in Case of the Missing Inflation: Fed Chair Jerome Powell’s testimony took the spotlight Tuesday, but Thursday brings a number that could help put his words into more context. That’s when Personal Consumption Expenditure (PCE) prices for January come out, a data point the Fed says it watches closely. When Powell said inflation is trending below the Fed’s 2% target, this is the indicator he’s talking about. In December, PCE prices rose just 0.1%, and core PCE prices, which strip out volatile food and energy, inched up 0.2%. For the year, PCE prices rose just 1.7%, with the core up a tepid 1.5%.

Looking ahead to Thursday, analysts expect a bit more movement in the index. Consensus among Wall Street analysts is for PCE prices to rise 0.4% in January, and for core PCE to climb 0.3%, according to Briefing.com. At this point, the markets pretty much bake in a March rate increase, but watch the futures market for what it says about farther out in the year and see if projections rise or fall based on the PCE number. One month is never a trend, of course, but PCE prices have lagged the consumer price index for a long time now, raising questions about whether inflation is ticking up or not.

Last Day Vigilance: Going into Wednesday, keep in mind that it’s the last day of the month and that means caution could be warranted. The last day of January brought some volatility, which at the time some analysts attributed to last-minute position-evening, sometimes called “window dressing.” That’s when fund managers sometimes buy under-performing stocks and sell over-performing ones at the end of a month or quarter, and sometimes that can mean surges in volume and volatility. Investors might want to be vigilant at times like these, especially after all the ups and downs that February brought.

Retail Earnings Could Help Answer Questions: After Wal-Mart (WMT) disappointed with its earnings last week and the stock plunged, questions arose about retail health. A weak retail sales report for January just added to the anxiety. At the time, we mentioned that investors might want to watch for earnings from Kohl’s (KSS) and Target (TGT) to see if WMT’s issues were isolated or signs of something wider spread. Well, Thursday morning brings results from KSS, so stay tuned. Department store Nordstrom’s (JWN) is scheduled to report the same day after market close. And TGT reports before the open on Tuesday, Mar. 6. Earnings season might be pretty much done, but these last embers are still worth sorting through for clues into consumer health.

Good Trading,
JJ
@TDAJJKinahan

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