(Thursday Market Open) The Fed raised rates for a second time this year and the fourth time since it entered the current rate-hike cycle in late 2015, but the outstanding question remains whether it will act again before 2018.
As far as the markets are concerned, anyway, it’s unclear. Fed funds futures show less than a 50% chance of another hike by end of year, and had been down below 40% before Wednesday’s rate hike. Stock futures trading pointed to a potential lower open Thursday, with S&P 500 (SPX) futures down sharply as the tech sector came back under pressure. Industrial production numbers are due a little later and some housing statistics are on tap Friday (see below).
The Fed still expects to gradually continue raising rates over the next few years, Fed Chair Janet Yellen said in her press conference Wednesday, and seems cheered by the generally healthy labor market. The so-called dot plot, charting FOMC members' individual expectations for the funds target at future dates, indicates officials haven’t scaled back. The funds rate projection for the end of 2017 remains 1.4%, meaning it forecasts another hike this year. Yellen gave projections of median short-term rates as 1.4% at end of this year; 2.1% at end of 2018; and 2.9% at end of 2019.
Significantly, however, Yellen acknowledged that core inflation has “edged lower,” driven significantly by what appeared to be “one-off” reductions in certain categories of prices like wireless telephone services and pharmaceuticals. With employment near its maximum sustainable level, the Fed still expects inflation to move up and stabilize at near 2% over the next couple of years, she added, but said the Fed is monitoring inflation closely due to the recent softness.
There wasn’t a big market reaction to the Fed’s move, perhaps not too surprising considering expectations of a rate hike had risen to as high as 99% in the futures market earlier Wednesday. The only part of the Fed’s statement that really provided any drama — and it wasn’t much — was its stated intention to start tapering its $4.5 trillion balance sheet this year. To some analysts, that sounded a bit more hawkish than expected, considering somewhat soft economic data seen lately.
If initial reaction is a guide, the back end of the yield curve isn't sensing an opening of the balance sheet floodgates. The 10-year Treasury yield, shown in figure 1 vs. the SPX, touched its lowest level of the year, perhaps in response to an acknowledgment in the FOMC statement that inflation has "declined recently." But a rate hike at the front end of the yield curve, combined with softness on the back end, could lead to market headwinds, especially in sectors such as financials that may be sensitive to a flatter yield curve.
Speaking of headwinds, the tech sector seems to be facing some again today, as shares of the “high five” tech stocks all fell sharply in pre-market futures trading. We’ll have to see if this weakness in tech spills over into the rest of the market, as it did a week ago. What’s happening in tech seems less related to fundamentals and more about profit taking and reassessment after the big run the sector has had.
Some key data crosses the wire today, with May industrial production out this morning. Export prices, import prices, and capacity utilization also are on the calendar. Overseas, the Bank of England kept rates unchanged, as many had expected. European markets, however, took a spill, with most down more than 1%.
Keep an eye on oil as well. U.S. futures prices posted their lowest close of the year Wednesday (see below), and could threaten the stock market if they keep falling. U.S. front-month oil futures fell below key support at $44.50 early Thursday before bouncing back slightly.
From a sector standpoint, some of the defensive parts of the market found support Wednesday, though it’s not clear if that had anything to do with the Fed statement or relatively soft retail sales and inflation data. Health care, telecom, and consumer staples were among the market leaders. Energy tanked nearly 2% thanks in large part to the oil price washout. Financials, which typically benefit from higher rates, roared back from what had been big morning losses to post gains for the day. It was quite the recovery, and somewhat surprising since 10-year yields stayed near lows.
Info tech fell more than 0.5% Wednesday, marking the third day in the last four that it’s been weak. But the Dow Jones Industrial Average ($DJI) set another record high.
The 24-hour news cycle continues with more D.C.-related political drama. Remember, however, that the networks need to keep going 24 hours a day. Keep some perspective as to what, if anything, reported out of Washington, actually matters from a market viewpoint.
Diving Deeper Into Retail Sales: Wednesday’s retail sales report sparked concern among some analysts, who noted the 0.3% monthly decline in the headline number and the fact that sales dropped the most for any month since early 2016. A look at the bigger picture helps put things in perspective. First, part of the decline reflected a more than 2% drop in gasoline sales, meaning consumers paid less for gas, normally a positive sign. Also, department store sales fell, which shouldn’t have surprised many considering what we saw from department store earnings last quarter. Meanwhile, if you look at retail sales compared to a year ago, they were up 3.8%, helped in part by strong e-commerce spending. Consumers are out there, but brick-and-mortar stores are going to have to find better ways to attract them.
Finding Housing: Friday morning brings housing starts and building permits data for May, coming off of weakness in the April report. The consensus among Wall Street analysts is for an uptick in both numbers, according to Briefing.com. Housing starts have been down two months in a row, and building permits have flattened recently. One factor to watch is single-family housing starts and building permits, both of which looked a little ragged in April. Rising home prices might be having an impact on this part of the housing market, so let’s see if the trend continued in May. Consensus is for housing starts to rise to a seasonally adjusted annual rate of 1.227 million and for building permits to rise to a seasonally adjusted annual rate of 1.25 million.
Oil Gets Squashed: U.S. front-month oil futures closed at seven-month lows, falling below $45 a barrel, after U.S. gasoline supplies rose in the government’s weekly report. Oil stockpiles fell, but not as much as the average Wall Street analyst had expected. Inventories keep showing a glut of oil. Still, futures managed to remain above what looks like key support at around the $44.50 level for the July contract. That’s still the price to watch, because a slide below that could set the market up for a further retreat toward $40, at least according to technical charts. Lower oil prices sound good for the consumer, but also might point to declining demand, something worth watching more closely.
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