The attention of Wall Street was squarely on the latest monetary policy decision from the Federal Reserve and the closely-watched commentary from Chairman Jerome Powell yesterday afternoon. Differing opinions on the Fed’s future course and the impact on the economy will clearly dominate investors’ thought process once again during today’s session. The major equity averages, which were rallying into the Federal Open Market Committee announcement at 2:00 P.M. (EDT), took another step up after some initial gyrations. Leading up to the Fed’s decision, the financial markets, based on recent stronger-than-expected inflation data, had priced in a three-quarter-point hike to the benchmark short-term interest rate, so they were not surprised by the move, hence the initial orderly reaction from the equity and bond markets.
However, yesterday’s relief rally looks the be rather short-lived, as the U.S. equity futures are down sharply this morning after the Bank of Switzerland announced a half-point hike to its short-term interest rate. The expectation was that Switzerland’s central bank would leave rates unchanged, but this hawkish move, along with the Bank of England’s rate hike today were viewed as signs that inflation is pressuring the global economy.
Those monetary moves in Europe follow the biggest interest-rate increase by the Federal Reserve in 28 years yesterday. The hawkish move included the disclosure by the central bank that it has raised the federal funds target rate for the next two years, which brought it more in line with the market’s expectation. The Federal Open Market Committee’s targets for 2022 and 2023 moved from 1.9% and 2.8% to 3.4% and 3.9%, respectively. The Fed Chairman also said that the central bank is moving aggressively to bring inflation down and may have to front-load the increases to accomplish this goal.
The market also seems to be a bit skeptical about Mr. Powell’s commentary that the economy and labor market are strong enough to handle more-restrictive monetary policies in the near term without a recession. He believes the Fed can get the inflation rate to around its 2.0% to 3.0% target by 2024, while still keeping the unemployment rate near a historically low level. The central bank’s 2024 jobless rate projection was revised higher, but only to 4.1%, which is still near what many would consider full employment. That said, the Fed leader did say that while the central bank can affect the demand side, the supply side of the coin is out of their control and has recently been exacerbated by surging commodities prices, especially for energy and food, due to the war in Ukraine and renewed COVID-19 lockdowns in China. This may lead to some more high readings on inflation in the coming months even as the Fed attempts to slow demand and, given this backdrop, it has many economists thinking that the odds of “hard landing” from the more-restrictive monetary policies and ultimately a recession are high.
This morning, we did get a few reports on the U.S. economy, including data on the homebuilding market. The Commerce Department reported that building permits and housing starts, which are a strong indicator of future residential construction activity, fell 7.0% and 14.4% on a month-to-month basis, respectively, in May. This was yet another sign that higher borrowing costs and home prices are making affordability a bigger concern for prospective buyers these days. The latest data highlight some growing concerns among the nation’s builders about near-to-intermediate housing demand. The interest rate backdrop has punished the stocks of the major homebuilders, a number of which are down more than 30%, year to date.
In addition to the housing data, we received data on the jobs market and the manufacturing sector. Specifically, the Labor Department reported that initial weekly jobless claims for the week ending June 11th came in at 229,000, which was unchanged from the previous week but above expectations. Meantime, we learned that manufacturing activity in the greater Philadelphia area fell 3.3% in June. Both reports could be taken as signs that the higher borrowing costs are starting to take a toll on the economy.
Given all the recent economic headwinds, the highly hawkish stance by the Federal Reserve, and a looming second-quarter earnings season that many think may show some signs of growing stress (i.e., weakening profit margins) in Corporate America, we recommend that investors exercise caution. We continue to suggest holding the stocks of high-quality companies with strong balance sheets and cash flows and keeping a significant amount of cash in one’s portfolio. With regard to the former, subscribers may want to give the stocks ranked 1 (Highest) and 2 (Above Average) for Safety a closer look, as those stocks as a whole have fared better than the broader market during turbulent times.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
