On a morning that is light on market-moving economic and earnings news, the main focus of Wall Street is still on yesterday’s Federal Reserve monetary policy decision (see below). However, we did get a few noteworthy economic releases before the opening bell. At 8:30 A.M. (EDT), the Labor Department reported that initial jobless claims for the week ending April 29th totaled 242,000, up from 229,000 in the previous week. We also learned that productivity declined 2.7% in April, with the closely watched unit labor costs figure rising sharply (+6.3% versus the consensus estimate of 5.5%). The latter figure suggests inflation remains sticky. On the positive side, the international trade gap deficit narrowed in March, to $64.23 billion. These reports provided mixed signals about the U.S. economy, but the overall consensus is that domestic growth is continuing to slow.
The major equity averages were under selling pressure this week ahead of the Federal Reserve’s much-awaited monetary policy decision yesterday afternoon. Escalating banking concerns following the seizure of failed regional bank First Republic Trust and its ultimate sale to banking giant JPMorgan Chase (JPM) weighed on the global equity markets and in particular the stocks of the regional lenders. Then the Federal Open Market Committee’s (FOMC) decision to raise the federal funds rate by 0.25%, to a range of 5.00% to 5.25%, and commentary from Fed Chairman Jerome Powell brought a rather muted reaction from the stock market. At the close of trading, the Dow Jones Industrial Average, the NASDAQ Composite, and the S&P 500 Index were down 0.8%, 0.5%, and 0.7%, respectively. This morning, we learned the European Central Bank (ECB) also raised its benchmark short-term interest rate by 0.25%, to 3.75%. This hike followed data released this week showing that inflation in the euro zone rose slightly, to 7%, in April.
The FOMC’s decision yesterday afternoon was not unexpected, but what investors were most interested in was the language in the Federal Reserve’s monetary policy statement, which included a change in the wording about future interest–rate policy. In the recent past, the Fed has said that future monetary policy tightening was appropriate. Yesterday, the May assessment said that the committee will now determine if future rate increases are necessary. The statement seemed to suggest that the Fed will pause in the coming months if inflation continues to ease, but did not close the door on another rate hike if the labor market remains tight and prices continue to run well above the Fed’s target rate.
Overall, the Fed statement had both hawkish and dovish aspects and we think that, along with no concrete evidence that the Fed will reverse course and begin cutting rates later this year, is the main reason why there was no big movement in the major averages in either direction. The equity futures are suggesting a modestly lower start to the trading day.
The Federal Reserve appears to be interested in seeing what the full effects of the most aggressive monetary policy tightening course in four decades will be. The central bank has now raised the federal funds rate five full percentage points since March, 2022. This increased the odds of an interest-rate pause at the June FOMC to just under 90% in the futures market. Where the discrepancy exists is that the Fed has been on the record saying that it may need to keep rates above 5.00% for an extended stretch to effectively fight still-stubbornly high inflation, while the stock market is pricing in short-term rates being cut by roughly 75 basis points by the end of this year.
We think the Fed will pause next month, given the uncertainty surrounding the banking system. There also are some concerns that if the central bank continues its highly restrictive policies it could lead to a more severe recession than economists are currently forecasting. The continued inversion of the Treasury market yield curve, falling oil prices, and the drop in the leading economic indicators last month, suggest a recession is likely later this year. This may be playing a role in the bigger decline in the economically sensitive stocks since the Fed’s decision.
Speaking of higher-growth stocks, Wall Street’s focus will be on the latest quarterly results from technology behemoth Apple (AAPL) after the close of trading this afternoon. On the earnings front this morning, drug maker Moderna (MRNA) reported revenue and earnings per share that exceeded consensus estimates. Food processor Kellogg Company (K) also beat the consensus earnings forecast, posting an adjusted March-quarter tally of $1.10. The Street was looking for $0.99 a share. Shares of Shopify (SHOP) and Shake Shack (SHAK) are up following their earnings reports.
So what is an investor to do in this environment? We would continue to exercise caution. With the Fed likely to keep the federal funds rate above 5.00% for an extended stretch, there will probably be more movement of funds out of bank savings accounts and into higher-yielding money market holdings (e.g., certificates of deposits). This may well put further stress on the regional lenders and could have a detrimental effect on riskier assets. In general, we continue to recommend investors look at the stocks of high-quality companies that have a history of generating steady earnings and cash flows during difficult economic times, maintaining strong balance sheets, and paying competitive dividends. Keeping a portion of one’s portfolio in shorter-duration Treasury notes and cash also may prove astute, given the near-term headwinds that have the potential to roil both the equity and bond markets. These include a slowing economy, stubbornly high inflation, banking worries, declining profits for Corporate America, and a looming debt ceiling battle on Capitol Hill. – William G. Ferguson
At the time of this article’s writing, the author held positions in one or more of the companies mentioned.
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