Hotter-Than-Expected Inflation Report May Clip the Dovish Wings Of the Fed

Futures flip as the Fed’s favored inflation report comes in hotter than expected, driving concerns over future rate hikes.
5 min read
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Key Takeaways

  • A Higher-Than-Expected Inflation Report Took a Little Wind Out of the Stock Market’s Sails

  • Big Tech Earnings Continue With More Misses and Rallies 

  • Investors Favoring Yields as Dividends Drive Investment Dollars 

Shawn Cruz, Head Trading Strategist, TD Ameritrade

(Friday Market Open) Equity index futures pointed to a higher open as investors looked to wrap up the week and month on a positive note, but a higher-than-expected inflation report pushed the dollar higher and pulled futures down off premarket highs.

Potential Market Movers

The Federal Reserve’s preferred inflation report, PCE Price Index, came in hotter than expected with core inflation growing at a pace of 0.6% for the month of June. This was higher than the forecast of 0.5% and well above May’s number of 0.3%. Inflation as measured by the report grew 4.8% year-over-year (YOY), which was also higher than the forecast of 4.7%.

The headline inflation number from the PCE report saw inflation grow 1% in June and 6.8% YOY.

Personal incomes also rose more than expected, rising 0.6% in June instead of the 0.5% forecasted. Rising incomes may be seen by investors and the Fed as wage inflation and as an extra layer of inflation concerns. Personal spending was also stronger in June, rising 1.1% instead of the projected 0.9%.

The report is causing some concern that the Fed may not be able to slow interest rate hikes as much or as soon as they would like. The 2-year Treasury yield climbed after the report to 2.91% from yesterday’s close of 2.88%. The 10-year Treasury yield (TNX) also edged a little higher to 2.7%.

A week ago, Twitter (TWTR) had a big earnings miss, but it seemed to reset expectations for this week as other misses weren’t hit as hard. With these new expectations, tech earnings haven’t been as bad as many had feared, which is being reflected in today’s earnings news.

After Thursday’s close, Amazon (AMZN) reported a quarterly loss of 20 cents per share against analysts’ profit estimates of nearly 13 cents per share. Barron’s reported that AMZN’s quarterly performance was one of the worst in its 25-year history. However, the company beat on revenue with a 7% increase, and much of the loss can be attributed to loss write-offs related to Amazon’s investment into EV truck maker Rivian (RIVN). That seemed to be enough for investors who bid up the stock more than 11% in after-hours trading.

Apple (AAPL) also reported earnings after the closing bell with beats on top- and bottom-line numbers leading to an afterhours rally of 2.57%. It’s a good quarter considering the factory lockdowns and shipping problems in China. Apple’s enormous cash position was of interest to many analysts because it suggests that company is gearing up for harder times. And harder times is where “cash is king.”

Intel (INTC) shares plunged 10% in after-hours trading because they reported a miss on earnings and revenue. The company also offered weak earnings guidance. Analysts came down on the company by downgrading the stock.  

Energy giants Exxon Mobil (XOM) and Chevron (CVX) reported better than expected top- and bottom-line numbers. XOM shattered its previous quarterly record profits thanks to soaring energy prices. Exxon was up 2.28% ahead of the opening bell. CVX earnings was boosted by increased fuel production and the stocks was boosted by a $5 - $15 billion buyback program as it climbed 2.67% in premarket action.

Procter & Gamble (PG) missed on its earnings estimates despite topping revenues. The stock was down 3.27% in premarket action as P&G issued flat revenue guidance.

Reviewing the Market Minutes

Stocks were a little lower to start the day as the U.S. Gross Domestic Product (GDP) revealed the economy contracted for two quarters in a row. The first Q2 GDP print was -0.6%, above Q1’s -1.3%. These numbers are commonly revised so it could be higher or lower in the future.

However, the bulls were able to charge through the backward-looking data to take the Dow Jones Industrials ($DJI), Nasdaq ($COMP), and the S&P 500® index (SPX) upward by 1.03%, 1.08%, and 1.21% respectively. The rally was relatively broad with NYSE advancers outpacing decliners more than 3-to-1.

It wasn’t just GDP that the bulls had to contend with. Meta Platforms (META) and Qualcomm (QCOM) reported earnings misses and closed respectively 5.2% and 4.5% lower on the day. It has been a big week for big tech, but most of them reported misses. However, the market has been able to look past some of the misses like Microsoft (MSFT) and Alphabet (GOOGL), but it’s been less forgiving for others.

The bond market saw yields slide as investors continue to digest the Federal Reserve’s dovish take on the economy on Thursday. The 2-year Treasury yield fell 12 basis points to 2.88%, while the 10-year Treasury Yield (TNX) dropped five basis points to 2.68%. The 2s10s ratio remains inverted but the moves did flatten the curve a bit. 

CHART OF THE DAY: INCOME INVESTING. The 10-year Treasury Yield (TNX—candlesticks) broke support (yellow line) on Thursday. The Real Estate Select Sector Index ($IXRE—pink) has surged while the 10-year yield has fallen. Both asset classes compete for income investor dollars and lower yields are proving to be a positive for Real Estate Investment Trusts (REITS). Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Three Things to Watch

CHASING YIELDS: With the end of Fed rate hikes potentially in sight, investors were buying up dividends on Thursday. The Real Estate Select Sector Index was the top performer, rising 3.7% while the Utilities Select Sector Index was second after gaining 3.52%.

REITs and utilities are known for higher-than-average dividends which puts them in direct competition with the bond market. Because bonds, particularly Treasuries, are considered safer investments, income investors will often favor fixed income when the yields are more attractive.

However, when Treasury yields retreat, income investors will often increase their allocation to the higher dividend yields found in these sectors.  

HEADING HOME: Much of the June housing data was unloaded towards the end of July and showed continued slowdowns in homebuilding, new home sales, and existing home sales. However, mortgage rates have started to pull back a little, which appears to be helping homebuilding stocks. The S&P Homebuilders Select Industry Index rose 2.09% on Thursday, which extended the rally it started back in June to about 22%.   

If the 10-year yield continues to fall, mortgage rates should follow because the two instruments tend to be tightly correlated. This could mean further gains for homebuilders. However, an inflation surprise could quickly turn both rates back around.

MISMATCHED SOX: The semiconductor space appears to be a bit of an enigma. Qualcomm (QCOM) and Intel (INTC) have reported earnings misses the last couple of days. However, other companies like Taiwan Semiconductor (TSM) and NXP (NXPI) have bit big.

The message for the industry group has been as mixed as the earnings reports. Some are saying that there’s a big slowdown in demand for chips while others are seeing strong demand. Despite the mixed messages, the PHLX Semiconductor Index (SOX) was up about 3.8% for the week.

Notable Calendar Items

Aug 1: ISM Manufacturing PMI and earnings from Activision Blizzard (ATVI), Simon Property (SPG), Devon Energy (DVN), and Aflac (AFL)

Aug 2: JOLTS job openings and earnings Archer Daniels Midland (ADM), Caterpillar (CAT), PayPal (PYPL), Starbucks (SBUX), and Occidental Petroleum (OXY)

Aug 3: ISM Non-Manufacturing PMI and earnings from CVS Health (CVS), Booking (BKNG), Moderna (MRNA), MetLife (MET), and Yum! Brands (YUM)

Aug 4: Initial jobless claims, Trade deficit and earnings from Eli Lilly (LLY), Amgen (AMGN), ConocoPhillips (COP), Cigna (CI), and Toyota (TM)

Aug 5: Employment Situation Report and earnings from EOG Resources (EOG), DraftKings (DKNG) and Norwegian Cruise Line (NCLH) 

Good Trading,

Shawn Cruz

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Key Takeaways

  • A Higher-Than-Expected Inflation Report Took a Little Wind Out of the Stock Market’s Sails

  • Big Tech Earnings Continue With More Misses and Rallies 

  • Investors Favoring Yields as Dividends Drive Investment Dollars 

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