This morning, we received a number of reports that were expected to be closely monitored by the Federal Reserve and Wall Street. At 8:30 A.M. (EDT), the Commerce Department reported that retail sales for the month of May increased 0.3%, a stronger-than-expected reading. That figure suggests that the U.S. consumer sector, which has been the backbone of the economic recovery from the COVID-19 pandemic, is still spending. Meanwhile, initial jobless claims for the week ending June 10th totaled 262,000, which matched the previous week’s revised figure, and import prices fell sharply last month, indicating some easing in prices. Lastly, business activity in the Empire State rose modestly, while manufacturing activity in the greater Philadelphia area continues to decline. On the international front, we learned at 8:15 A.M. (EDT) that the European Central Bank raised its short-term interest rate by 25 basis points, citing still stubbornly high inflation on the Continent. The equity futures, which were modestly lower heading into the releases, did not change much and are pointing to some profit taking, primarily in the tech-heavy NASDAQ Composite, when trading kicks off stateside.
In a week that has had no shortage of headline—and market-moving—reports on the economy, the attention of Wall Street is clearly on the Federal Reserve and its battle to tame inflation. At 2:00 P.M. (EDT) yesterday, the Federal Reserve released its monetary statement, which showed that the central bank paused on the interest-rate front at this month’s Federal Open Market Committee (FOMC) meeting. The statement, which also included the raising of the 2023 federal-funds target to 5.60%, was viewed as a hawkish pause. For the Fed to get the benchmark short-term interest rate to its new level, it would likely require two more hikes this year. Initially, Treasury market yields rose on the news, while the major equity averages, which were mixed heading into the Fed statement, fell on the hawkish tone by the central bank. The interest-rate sensitive small-cap companies and their stocks suffered the biggest declines yesterday on the possibility of rates going higher in the second half of this year.
However, the major averages, most notably the S&P 500 Index and the tech-heavy NASDAQ Composite, rallied off the initial drop and Treasury yields eased some. The price-weighted Dow Jones Industrial Average suffered the day’s biggest setback, but that was mostly driven by a sharp drop in the stock of UnitedHealth Group (UNH), which was responsible for 207 points of the index of 30 bellwether companies’ 233-point decline. We sense that the market does not believe that the Federal Reserve is 100% committed to adhering to its goal of getting the federal-funds target to 5.60%, at least in the very near future. There is also a thought that getting to that level could be spread over several months depending on credit market conditions.
In his post-monetary statement press conference, Federal Reserve Chairman Jerome Powell reiterated that all future interest-rate decisions will be data driven. (That is when the major averages reversed course and began their intra-day recoveries.) Thus, if the current trend of inflation coming down holds true in the June price data (due before the July FOMC meeting), Mr. Powell said that the committee is open to reassessing their position on rates. It should be noted that the Federal Reserve also is looking at data (i.e., labor, housing, and rents) that is more lagging than forward looking, so there is a good possibility that labor market conditions will loosen some and prices will continue to come down, as the full effects of raising the federal funds rate by five full percentage points in just over a year are realized. While the odds of a quarter-point increase to the federal funds rate at the July FOMC meeting currently stand above 60%, the odds of another rate hike at any of the three following meetings are less than 15%. Wall Street clearly believes that the Federal Reserve is near the end of its rate-hiking cycle. There also is a thought that the central bank will not want to over-tighten the credit market and risk another regional bank failure, like the three seen in March, and put further stress on a struggling commercial real estate market.
The Fed statement also contained a brighter near-term outlook on the U.S. economy, with the bank’s 2023 GDP outlook better than the previous meeting. Although growth is still likely to be subdued, labor is holding up well (the bank cut its 2023 forecast for unemployment from 4.5% to 4.1%) and inflation is moving in the right direction, even if not as fast as Fed officials would have envisioned. The data also give some credence to the notion that a soft landing for the economy is possible and a recession would be mild and rather short-lived. This probably gave some support to equities, even as the Fed struck a more hawkish monetary policy tone yesterday.
Meantime, the economic outlook for China is worsening. The world’s second-largest economy reported smaller-than-expected gains in both retail sales and industrial production, and detailed some notable weakness in its property sector. Roughly three years of COVID-19 shutdowns and lost income have taken a toll on the savings accounts of Chinese consumers, who are not spending. Given these struggles, China’s central bank cut medium-term lending rates overnight after it lowered two short-term lending rates earlier this week. This, along with sentiment that China will announce a stimulus plan next week, is a coordinated effort to try to jumpstart that nation’s struggling economy. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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