The Fed Goes Hiking

By Ben Norris, CFA, Securities Research Analyst, Associate Vice President

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When it’s my week to write this recap I tend to work through the prior week’s events chronologically before touching on what investors can expect for the week ahead. However, markets are in a unique situation right now, so I’m going to flip that normal progression and discuss this week’s events first.  The Federal Open Market Committee (FOMC) begins its two-day policy meeting tomorrow and will wrap up with a decision on raising interest rates Wednesday afternoon. Federal Reserve Chair Jerome Powell has consistently said that the FOMC expects to take a measured approach to raising target interest rates. What this means in practice is that they will consistently raise interest rates by 0.50% at their next several meetings and don’t expect to deviate from that plan. However, CME Group’s Fed Watch tool indicates that the market thinks there is a 30% chance that the FOMC will buck that trend and raise rates by 0.75% at this week’s meeting. A week ago, the market was implying just a 3% chance that the FOMC would pursue a 0.75% hike. So, what happened that would cause such a drastic change in expectations in just a week’s time?

Friday saw the release of May’s Consumer Price Index (CPI). The consensus expectation was that the reading would show inflation peaked in April and would begin to move lower through the rest of 2022. Consensus expectations were wrong – CPI increased 8.6% year-over-year in May, up from the previous reading of 8.3% and ahead of the 8.2% expected. Notably, this is the highest yearly increase in CPI in over 40 years – not something that Jerome Powell and company will want to write home about. Many thought that a slowdown in inflation would lessen the burden on the Fed to get prices under control and provide some relief for a stock market that has been under near constant pressure in 2022. Core CPI, which removes the influence of food and energy prices, also came in above expectations (at 6.0% year over year) but did show a slight slowdown vs. the prior reading.

These numbers convinced investors on Friday that the Fed has a long and difficult road ahead as it tries to get prices stabilized without plunging the economy into a recession. Accordingly, the S&P 500 (SPX) fell nearly 3% on Friday, taking the index’s weekly loss to more than 5% and its year-to-date loss to 17.6%. Growth oriented stocks were hit particularly hard as they tend to be more sensitive to higher rates than their value counterparts. The Russell 1000 Growth lost 3.7% last Friday while the Russell 1000 Value lost just 2.3%. I expect that markets will be choppy this week at least until Wednesday’s FOMC statement and depending on how the FOMC tea leaves are read, we could see more volatility to round out the week.

In contrast to Friday, the rest of last week was mostly quiet and saw mixed developments on the economic front. Monday saw a better-than-expected reading on the U.S. Trade Deficit, which was somewhat surprising given that the U.S. Dollar continues to strengthen relative to other major currencies. The improvement probably has more to do with the ongoing lockdowns in China and turmoil in parts of Europe than long term trade trends, but it still bodes well for the next GDP report. The closely watched 10-year U.S. Treasury yield did eclipse 3% for the first time since early May however, as investors remained jittery about interest rates and inflation. Speaking of the 10-year yield, mortgage applications dropped to a 22-year low on Tuesday as the typical rate for a 30-year loan eclipsed 5% and is at its highest level in over a decade. Mortgage rates are influenced by the 10-year Treasury rate.

Energy prices continued their rise last week with Crude Oil prices exceeding $120 per barrel. The national average price for a gallon of gas has reached $5 a gallon as a result and has ramped up pressure on consumers. Thursday saw employment numbers come in relatively solid and it’s clear that the U.S. labor market remains on solid ground. In fact, continuing jobless claims remain at their lowest level since 1969. Unfortunately, the strong labor market isn’t helping the Fed’s fight against inflation, and we’ll likely have to see weaker jobs numbers before prices come under control.

This week’s slate of economic data will clearly be headlined by the FOMC statement and press conference on Wednesday and investors should expect markets to remain choppy through the week especially leading up to and after Chair Powell’s press conference.

Date Report Previous Consensus
Monday 6/13/2022 NY Fed 1 & 3-year Inflation Expectations (May)

3.9% / 6.3%

Tuesday 6/14/2022 NFIB Small-Business Index (May)

93.2

93.0

Producer Price Index (May)

0.5%

0.8%

Wednesday 6/15/2022 FOMC Statement and Press Conference

Retail Sales (May)

0.9%

0.2%

Import Price Index (May)

0.0%

1.2%

NAHB Home Builders Index (June)

69

68

Thursday 6/16/2022 Initial Jobless Claims (June 11)

219,000

229,000

Continuing Jobless Claims (June 4)

1.31M

Philadelphia Fed Manufacturing Index (June)

2.6

7.0

Friday 6/17/2022 Industrial Production (May)

1.1%

0.4%

Capacity Utilization (May)

79.0%

79.3%

 

Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.