Flying High: Dovish Fed Helps Boost Bulls as Market Eyes Records

Dovish commentary from Fed Chair Jerome Powell this week has reinforced expectations of a potential rate cut at the central bank’s meeting later this month.

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6 min read
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Key Takeaways

  • Auction for 30-year Treasuries sees weak demand

  • Trump drops proposal to end rebates from government drug plans

  • Bets on 50-basis-point rate cut regain some ground

(Friday Market Open) In this information age, there are many ways to stay in touch with what’s going on. And this week, the market seems to have gotten its latest sense of direction on the wings of a dove.

Specifically, dovish commentary from Fed Chair Jerome Powell this week that reinforced expectations of a potential rate cut at the central bank’s meeting later this month has helped boost stocks.Even bets on a 50-basis-points cut, which had been cut back cut back after last week’s bumper jobs report, regained some ground. But most bets are for a cut of 25 basis points. 

Basically, it seems that the market is looking forward to corporate borrowing costs being lowered and what that can mean for company expansion and profits. There’s also hope that lower rates could spur more consumer borrowing for big-ticket items like cars and dishwashers, which might help stimulate gross domestic product growth. Still, there’s room for caution given that rate cuts go hand in hand with expectations of weaker economic conditions, which can damage companies’ bottom lines.  

There’s also an argument to be made to not get too carried away on the bullish side given that earnings season is about to heat up, and we could hear some bearish commentary from company executives about the state of the economy and their thoughts on the trade war between the United States and China.

The tariff issue remains unresolved and is still a big overhang for the market amid worries that it could dent global economic growth. There have been rumblings in economic data from around the globe that suggest that is already starting to happen, and the trade issue appears to be factoring in the Fed’s consideration of a rate cut. 

Stock and Bond Roundup

On Thursday, the S&P 500 Index (SPX) and the Dow Jones Industrial Average ($DJI)rose, with the $DJI closing at a record above 27,000 and the SPX finishing at an all-time closing-high just below the key psychological benchmark level of 3000. If this morning’s trading direction and magnitude holds up, we could see those records broken today.

Even with the chair of the Federal Reserve telegraphing an almost certain rate cut, longer-term bond yields managed to rise yesterday. Inflation data from the consumer price index released Thursday rose more than expected (see more below), which dampened sentiment in an auction for 30-year treasuries. Because of their longer date, those securities are particularly sensitive to inflation eating away at the value of dollar-denominated investments. 

With the jump in yields, the Financials sector turned in the second-best performance of the day. Banks tend to do better when longer-term yields allow them to earn more interest on loans compared with what they pay on deposits. 

This could be setting us up for an interesting scenario later. If longer rates continue to rise and the Fed cuts its short term rate, that steepening of the yield curve could be a catalyst for the Financials sector to move higher, perhaps helping create a market-leadership role for a sector that has had trouble getting momentum going.

A Tale of Two Health Cares

Thursday saw two parts of the Health Care sector diverge widely. 

Cigna (CI), Anthem (ANTM) and UnitedHealth Group (UNH) were the top three gainers in the SPX after the Trump administration dropped a proposal that would have nixed rebates from government drug plans as part of an effort to bring prescription drug prices down. 

That plan would have eliminated the rebates that drug makers pay to pharmacy benefit managers working with Medicare and Medicaid to negotiate drug prices for buyers such as health insurance companies. Hence the gains in health insurance companies and companies that own PBMs.

However, pharmaceutical companies didn’t fare so well. “Now that the rebate rule is off the table, with the Trump administration still looking for a big win on drug pricing, investors are worried that whatever comes next will hit the drug companies hard,” as Barron’s put it. 

That left a big chunk of the Health Care sector on the opposite end of the S&P 500, with Merck (MRK) and Eli Lilly (LLY) among the biggest three losers in the index for the day. The opposing sentiment kept the sector at just a 0.02% gain for the day.

Figure 1: The yield on the 10-year Treasury moved higher Thursday on stronger-than-expected inflation data that led to weak demand in a Treasury Department auction.  Data Source: Cboe Global Markets. Chart source: The thinkorswim® platform from TD AmeritradeFor illustrative purposes only. Past performance does not guarantee future results.  

Core Price Data:Key inflation data out Thursday came in hotter than expected. The core reading, which strips out volatile food and energy prices, for the Labor Department’s consumer price index showed a rise of 0.3% for June when a Briefing.com consensus showed an expectation for a 0.2% rise. On an annual basis, the measure rose by 2.1%. “The key takeaway from the report was that the (year-over-year) uptick in core CPI should seemingly diminish the prospect of a 50-basis-points rate cut at the July meeting,” Briefing.com said. Still, the 50-basis-bets have risen on Powell’s commentary. 

GDP Nowcast: As inflation seems to be on the rise, so to do the prospects for the U.S. economy, although expectations for second-quarter gross domestic product in the United States aren’t stellar. On Wednesday, the latest forecast from the Atlanta Fed’s GDPNow model estimate for seasonally adjusted annual real GDP growth rose 0.1 percentage point to 1.4%. The stronger-than-expected employment report from the Bureau of Labor Statistics last week was the driving factor. 

Rate Cut Hopes: While history is no guarantee of future performance, it seems that market participants are hoping for a bit of history repeating itself. “The market’s focus for the month is the Fed, with investors hoping for a replay of 1995, in which the end of a Fed rate-tightening cycle was replaced by a rate-easing period,” investment research firm CFRA said. That year, the S&P 500 rose 34%, with nearly two-thirds of that coming before the initial cut in early July, according to CFRA. “A déjà vu performance would still imply a double-digit price rise for the S&P 500 in the final five months of the year, provided the FOMC follows through with the highly anticipated cut later this month – which we think they will,” CFRA said.

Good Trading,

JJ 

@TDAJJKinahan 

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Economic calendar for week of July 8. Source: Briefing.com

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Key Takeaways

  • Auction for 30-year Treasuries sees weak demand

  • Trump drops proposal to end rebates from government drug plans

  • Bets on 50-basis-point rate cut regain some ground

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