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Hawk Talk: Fed Rate Hike Worries Inject Turbulence Into Markets

May 23, 2016

(Monday Pre-Market) How the tables have turned.

Just a few weeks ago, Fed-funds futures at the Chicago Mercantile Exchange (CME) predicted about a 6% chance of a Fed rate hike in June and under a 20% chance for July. But after last week’s slew of hawkish Fed speeches, accompanied by a similarly hawkish tone in the Fed’s meeting minutes, those chances have risen abruptly. As of midday Friday, Fed-funds futures were pricing in about a one in three chance of a June hike and even more interestingly, a 57% chance for a July rate hike.

With a possible Fed rate hike right back on the table, the markets grew volatile last week and also could face more volatility in the weeks ahead as the Fed’s June 14-15 meeting approaches. The Chicago Board Options Exchange’s (CBOE) volatility index (VIX) rose at times last week to levels not seen since March, though it was on pace to finish the week well off its highs.

While the Fed-funds numbers don’t mean a hike is assured, they certainly put a different spin on things than there was a few weeks back, when many investors thought the Fed might not hike until near the end of 2016 or maybe not at all. Now, there’s more of a sense that there could be two hikes this year. And some analysts see that as healthy, giving the market a chance to break out of the shackles of its interest rate fixation to trade on fundamentals in a more normal rate environment. Other analysts say the Fed should be cautious, considering weak Q1 U.S. economic growth and earnings, as well as overseas worries like the June 23 British referendum on whether to leave the European Union, or “Brexit.”

Whatever the Fed decides, the earnings season is definitely behind. It’s a long way until Q2 earnings season, so the market is likely to focus on data points between now and the mid-June Fed meeting to see if the economy is truly emerging from its Q1 doldrums.

This coming week could bring some indication of that, with the government’s second estimate for U.S. Gross Domestic Product (GDP) scheduled for Friday (see below) and April orders for durable goods on Thursday. The durable goods number could give a sense of what might happen in terms of big manufacturing items such as cars, dishwashers and dryers. Durable goods rose just 0.8% in March and fell 3.1% in February. Earlier this month, the government reported strong April retail sales. Does this bode well for durable goods orders that same month? We’ll find out next Thursday.

Even though earnings season is behind, some earnings are on schedule next week, including retailers Best Buy (BBY) on Tuesday and Tiffany & Co. (TIF) on Wednesday.

One interesting development last week was that crude oil futures and the stock market seemed to influence each other less than earlier this year. Crude oil spent much of the week rising even as the S&P 500 Index (SPX) spent much of the week falling. Back in the first month of the year, the correlation between the SPX and crude was 92%; now it’s down to around 78%. That may be why there’ve been fewer headlines lately about the oil market. But that could change if nearby oil futures rise above resistance at $50 or dip below support at $44. The Fed remains the big gorilla in the room, but oil is still an important data point.

S&P 500


The S&P 500 (SPX), plotted through midday Friday on the TD Ameritrade thinkorswim platform, continues to pivot around the 2050 mark, a psychological level for the market . Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Second Time the Charm for GDP? This coming Friday brings the government’s second estimate at Q1 GDP, a huge indicator of the health of the economy. The government’s first estimate was a weak 0.5%, and at the time, many analysts blamed winter blahs, the ailing Chinese economy and low oil prices. What will the second estimate tell us? Looking back at last year’s second estimate for Q1, there was a big fall-off, with GDP revised to negative 0.7%, down from the first estimate for a rise of 0.2%, which shows that there can be quite a change from one estimate to the next. But as Henry Ford once said, “History is more or less bunk,” so last year’s downward revision doesn’t indicate how this year’s might turn out. Based on the first estimate, it would be very surprising if the second estimate shows any real jolt for the economy, but there’s always a chance the number could move the market. It’s also worth watching the Atlanta Fed’s GDP Now indicator for clues to Q2 growth. That indicator recently stood at 2.5%, a slight downward revision from a reading of 2.8% earlier this month.

On the Home Front: Friday’s existing home sales number gave another reason to consider apparent strength in the housing market after a surge in housing starts reported earlier in the week. Sales rose 1.7% in April from the prior month to a seasonally adjusted annual rate of 5.45 million, the National Association of Realtors (NAR) said. That was a little above the consensus estimate, and came despite what the NAR called “ongoing inventory shortages and faster price growth.” A surge of sales in the Midwest drove the existing home market, NAR added. On Thursday, New York Fed President William Dudley said the economy “is on track to satisfy a lot of the conditions” for a rate hike. Could these strong housing data play into the Fed’s decision? We’ll see.

Post-Memorial Day Blahs? Next week is the last before the U.S. Memorial Day holiday, and history shows (there’s that “history word again) that the market tends to sag in the first weeks of summer. Since 1945, the S&P 500 Index (SPX) has fallen an average of 0.01% in June, according to research by S&P Global Market Intelligence, making June the ninth-best month of the year performance-wise for the index. Still, during that time period, the market has risen in June 51% of the time, and in its best June, rose 8.2%.

Good Trading,

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