The attention of Wall Street turned to the Federal Reserve yesterday afternoon, and investors clearly liked what they saw and heard, with the central bank’s monetary policy decision and commentary from Federal Reserve Chairman Jerome Powell greeted kindly by Wall Street. The Fed’s decision to raise the benchmark federal funds rate by 50 basis points, to 0.75% to 1.00%, at its May Federal Open Market Committee (FOMC) meeting was already baked into market valuations and that, combined with what was deemed to be slightly less hawkish commentary from Mr. Powell, ignited a broad-based rally into the closing bell.
The Dow Jones Industrial Average, the NASDAQ Composite, and the S&P 500 Index, which were mixed heading into the FOMC statement, finished 932, 401, 125 points higher, respectively; the S&P 500 move was the largest daily gain since May of 2020. The rebound was led by many of the high-growth names that had fallen sharply recently on the expectations of rising borrowing costs. It also included the mega-cap technology names.
This morning, we received another report from the Labor Department, with initial jobless claims for the week ending April 30th totaling 200,000. This was up 19,000 from the prior week and it was the first time at or above the 200,000 mark since February 11th. The release comes ahead of tomorrow’s much-anticipated report on April nonfarm payrolls. We also got the latest data on productivity and that report, as expected, showed a sharp decline (-7.5%), hurt by a jump in labor costs (up more than 11%). The equity futures, which were modestly lower heading into the economic data, did not change much and are still presaging some profit taking after the best session for stocks in two years yesterday.
Meanwhile, we did get some notable earnings reports after yesterday’s closing bell. But they’re being overshadowed by the Fed’s decision. E-commerce platforms eBay (EBAY) and Etsy (ETSY) posted decent quarterly results, but the stocks of both companies are lower in pre-market action on reduced near-term outlooks. The latter company noted that there is less disposable income right now for consumers (due to inflation) and more places for them to spend it as pandemic restrictions have eased. On point, Booking Holdings (BKNG) shares jumped after the Internet travel marketplace company reported quarterly results and said that it is benefiting from a pickup in travel, as the impact of the COVID-19 virus continues to lessen. This morning shares of Shopify (SHOP) and Wayfair (W) are down on quarterly profit misses at both web shopping sites.
As noted, the market’s sizable rally was driven by the commentary from Fed Chairman Powell, who said the central bank is not actively considering a 75-basis-point hike. (In specialized futures markets, the odds of a three-quarter-point hike at the July FOMC meeting dropped from 51% before the Fed statement to now less than 10%.) Although the Fed leader telegraphed at least two more half-percentage-point hikes, perhaps at the June and July FOMC meetings, taking the very hawkish 75-basis-point reduction off the table, along with a clear outline of how the lead bank plans to reduce its bloated balance sheet (more below), removed a lot of uncertainty from the market and that provided a big boost for stocks.
Likewise, positive commentary from the Fed leader about the state of the U.S. economy and the suggestion that inflation may have peaked in March and April also helped market sentiment. Mr. Powell noted that “household and business spending remains strong, while job gains have been robust.” This morning, a survey released from credit card company Mastercard (MA) showed that retail sales remain steady and the consumer is continuing to spend.
The relief rally also was driven by Mr. Powell’s comments that the lead bank will ease into the period of quantitative tightening, which is the process where the bank removes liquidity from financial system by selling assets. The quantitative tightening will start next month, with monthly asset sales totaling $47.5 billion of securities. This will be the rate through August and thereafter the monthly pace of asset reductions will total $95 billion ($60 billion of Treasuries and $35 billion of mortgages). The market liked the transparency and also comments that the Federal Reserve will remain flexible on the balance sheet reduction front if the impact on growth and the labor market is deemed too negative.
In all, the Treasury market seemed to take the 50-basis-point interest-rate hike, the first in 22 years, in stride, with a widening of the spread between the two-year and 10-year Treasury note yields. Heading into the decision, the spread was less than 20 basis points, but following the Chairman’s remarks that range widened. The steepening of the yield curve would alleviate some of the concerns about a near-term recession. The yield on the benchmark 10-year Treasury note, which topped 3.00% earlier this week, declined some yesterday, which provided an additional boost for the recently battered higher-growth stocks, particularly those in the technology sector. That helped spark a 4% jump for the NASDAQ Composite. Conversely, the price of the CBOE Volatility Index (or VIX), also known as the “fear gauge,” fell to around 25 yesterday after climbing to near 35 last week, suggesting an increased appetite on Wall Street for riskier assets.
Going forward, we think those companies that demonstrate the pricing power to push some of the higher operating costs onto the customer will fare the best and their stocks are more likely to be rewarded on Wall Street. From a sector perspective, the recent jump in oil and gas prices is helping the stocks of the energy companies, while the continued climb in mortgage rates (the rate on the 30-year fixed mortgage recently topped the 5.00% mark after falling to below 3.00% at the start of the pandemic) is having an adverse effect on the performance of the homebuilding equities.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
