The Federal Reserve on Wednesday surprised markets with a fortification of its higher-for-longer stance on interest rates, penciling in only half as many rate cuts next year as had been expected.
Fed officials kept the central bank’s policy rate at a 22-year high, but redrew their so-called “dot plot,” a chart of the potential path of short-term rates over time, in a less favorable way for borrowers.
The…
With the Federal Reserve preparing to release updated inflation and interest-rate forecasts on Wednesday, the proverbial elephant in the room will probably be missing from the equation: The full impact of rising oil prices, according to investors, traders and strategists.
Oil prices touched fresh 2023 highs on Tuesday and settled above $90 a barrel, a byproduct of this month’s decision by Russia and Saudi Arabia to extend production cuts into year-end. Just a day ago, Mike Wirth, chief executive of Chevron
CVX,
put the prospect of oil crossing $100 a barrel on the map and the price at the gas pump went above $6 a gallon in Southern California — reigniting fears about a revival of inflation.
It’s too soon to say whether the run-up in energy prices will spill over into the narrower core inflation gauges that the Fed cares most about, TD Securities strategist Gennadiy Goldberg said via phone. As a result, policy makers may look past the impact of higher energy prices on their longer-term inflation and rate outlook Wednesday, he said. Fed officials are hesitant to place too much weight on energy or food as components of inflation, anyway, because of their volatile natures.
In One Chart: Why crude-oil rally can’t be ignored by investors — or the Fed
However, some traders are worried that such an omission could be a mistake considering all the other price pressures playing out, such as strikes against the three major U.S. automakers.
UAW strike: Union sets Friday deadline for further possible strikes
“Is it a mistake to not factor in oil? I personally think it is, but I’m probably in the minority on that,” said Gang Hu, an inflation trader at New York-based hedge fund WinShore Capital. “The combination of oil and strikes by the United Auto Workers presents a structurally unstable inflation picture.”
“If the Fed is the one that provides insurance against inflation and is not doing anything, the market will seek inflation protection by itself and it will look like inflation expectations are unanchored. This is the risk,” Hu said via phone.
Nervousness around the prospect of a higher-for-longer message on rates from the Fed helped send the 2-
BX:TMUBMUSD02Y
and 10-year Treasury rates
BX:TMUBMUSD10Y
to their highest levels in more than a decade on Tuesday. The ICE U.S. Dollar Index was off by less than 0.1%.
Read: How Fed’s higher-for-longer theme may play out in Treasurys and the dollar on Wednesday
U.S. stock indexes
DXY
COMP
finished lower on Tuesday, led by a 0.3% drop in Dow industrials.
Investors and traders are expected to zero in on the part of the Fed’s Summary of Economic Projections that reflects where the fed-funds rate target, currently between 5.25%-5.5%, could go in 2024. As of June, policy makers penciled in the likelihood of four 25-basis-point rate cuts next year after factoring in more tightening this year, and they saw inflation creeping down toward 2% in 2024 and 2025, as well as over the longer run.
See: Why Fed’s response to this key question could spark 5% stock-market pullback or ‘solid rally’
Many in financial markets are clinging to the likelihood of no Fed rate hike on Wednesday, and see some possibility of just one more increase in November or December before rate cuts begin in the middle or final half of next year. But inflation traders now foresee seven straight months of 3%-plus readings on the annual headline CPI rate, from September through next March; that’s up from five consecutive months seen as of last Wednesday and complicates the question of where the Fed will go from here.
“The Fed’s rate decision on Wednesday was already decided a while ago, when officials started to communicate that a pause would be the likely outcome,” said Mark Heppenstall, chief investment officer of Penn Mutual Asset Management in Horsham, Pa., which oversaw $32 billion as of August.
“On the margin, we might see higher oil prices make a modest impact on rate projections,” he said via phone. However, “it’s too early for the story to change on disinflation and all the progress made so far.”
The past six weeks have left investors with more questions than answers about the outlook for U.S. monetary policy and, by extension, financial markets.
And although the Federal Reserve is expected to leave its policy interest rates on hold Wednesday, Chairman Jerome Powell could still rattle markets as he’s probed for clues about the central bank’s thinking.
Powell’s statement is expected to hew to what he said at the Jackson Hole, Wyoming, symposium in August and before that, during the central bank’s July press conference, but market analysts say the question-and-answer session with reporters and the updated “dot plot” of policy makers projections for interest rates could potentially furnish market-moving news.
See: U.S. economy is trending in the Fed’s direction, so expect Powell to tread carefully next week
“Just because this meeting isn’t widely considered to be ‘in play’ doesn’t mean it is insignificant,” said Steve Sosnick, chief strategist at Interactive Brokers, during a phone interview with MarketWatch.
“The fact is, the Vix is relatively low. That indicates a very sanguine, if not complacent market. And a complacent market can sometimes be more susceptible to a negative shock.”
The Cboe Volatility Index
VIX,
better known as “the Vix” or Wall Street’s “fear gauge,” finished below 14 on Friday, even as the Nasdaq Composite
COMP
and S&P 500
SPX
logged back-to-back weekly losses. Markets have seesawed recently as inflation has reaccelerated while the U.S. labor market and broader economy have slowed.
What will investors be looking for, exactly? Presently, investors expect the Fed could start cutting interest rates again by the middle of next year. Anything that could disabuse them of this notion could undercut U.S. stocks while boosting Treasury yields and the U.S. dollar, analysts said.
Liz Ann Sonders, chief market strategist at Schwab, said clues could potentially surface during the Q&A at the post-meeting press conference, which often has more of an impact on markets than Powell’s statement.
“It is that 45 minutes to an hour that tends to be more market moving,” Sonders said during a phone interview with MarketWatch. “It is what they say about higher for longer and expectations around rate cuts in 2024, and whether Powell pushes back against that.”
Since the beginning of August, more data has emerged to suggest that the U.S. economy might finally be starting to respond to the pressure from the Federal Reserve’s most aggressive campaign of interest-rate hikes since the 1980s. Corporate and personal bankruptcies have climbed.
See: Bankruptcies spiked in August — the post-COVID rebound ‘is becoming a reality’
There have also been indications that the torrid postpandemic labor market might be starting to cool. The Labor Department’s monthly jobs report showed fewer than 200,000 jobs were created in August, while figures from the prior two months were also revised lower, and the unemployment rate ticked higher to 3.8%.
At the same time, consumer-price inflation has accelerated for two months in a row. Some on Wall Street have started to worry about stagflation, and financial markets are now pricing in about even odds that the Fed will leave interest rates on hold.
A report earlier this week showed consumer prices rose 3.7% over the 12 months through August, while the rise for the month was 0.6%, the biggest increase in 14 months.
Adding to the complicated picture, the resumption of student loan payments in October has revived concerns about the consumer despite relatively robust retail-sales data released earlier this week, while an auto worker strike involving all of the “Big Three” U.S. carmakers and the threat of a government shutdown are also sowing fears about a hit to the economy.
“The triple threat from the resumption of student loan payments, a government shutdown and a strike by auto union workers could significantly weigh on GDP growth in Q4,” said EY Chief Economist Gregory Daco in emailed commentary.
Powell could be asked to weigh in on any or all of these. He also could be asked to directly address investors’ expectations for the timing of the Fed’s initial rate cut of the cycle. Expectations for a policy pivot already proved premature last summer, which caused a brief but powerful bear-market rally to fizzle.
A repeat of this could again create problems for stocks, Sosnick said.
“Let’s see if the Fed agrees with the market’s assumptions about rate cuts,” he added.
Traders expect the central bank to keep interest rates on hold Wednesday, with market-based odds seeing a pause as a virtual certainty, according to the CME’s FedWatch tool, which measures expectations based on trading in Fed funds futures. Expectations for another hike later this year are roughly split.
See also: 4 things to watch for at next week’s Fed policy meeting
Stocks ended lower Friday as investors assessed the start of a United Auto Workers strike against Ford
F,
General Motors
GM,
and Stellantis
STLA,
and awaited next week’s Fed decision. The Dow Jones Industrial Average
DJIA,
declined nearly 290 points, or 0.8%, to close near 34,619, according to preliminary data. The S&P 500
SPX,
shed 0.8% and the Nasdaq Composite
COMP,
slid 1.6%. The declines left the Dow with a weekly gain of 0.1%, while dragging the S&P 500 to a 0.2% drop and leaving the Nasdaq down 0.4%.
Three powerful dynamics in the global economy are expected to play a significant role in investors’ multi-asset allocations over the next five years, according to a 132-page report from Rotterdam-based asset manager Robeco.
The first is labor’s likely increased bargaining power, with the outcome of any tussle between businesses and their workers probably being determined by wages in a sticky inflation environment, based on the report compiled by strategists Laurens Swinkels and Peter van der Welle on behalf of the multi-asset team at Robeco, which manages $194 billion in assets. The second is the end of monetary-policy leniency and the potential for central banks to lock “horns” with governments over the appropriate level of borrowing costs. The third is the dawn of “multipolarity” as the U.S. and China struggle for power.
Taken together, this “triple power play” is already starting to unfold, shifting investors into a world of higher risk-free rates and lower expected equity risk premiums, according to the asset manager. Risk premium is a gauge of relative value for stocks, helping investors understand what their short-term gain might be when taking on the additional risk of buying equities or investing in stock funds.
Robeco provided its forecasts for five-year annualized, projected returns on a range of assets held by euro- and dollar-based investors — including developed- and emerging-market equities, bonds, and cash.
The firm’s base-case scenario, which Robeco’s team refers to as a “stalemate,” calls for a mild recession in 2024, consumer-price inflation in developed economies to remain around 2.5% on average heading toward 2029, and real GDP in the U.S. to average 2.3% or below what the S&P 500 index
SPX
currently implies.
That benign growth outlook is expected to be accompanied by macroeconomic volatility, plus a “tug of war” between central bankers reluctant to lower interest rates and governments in need of low borrowing costs — which “means there is not enough monetary policy tightening to remove demand-pull inflation.” Under such a scenario, developed-market equities are likely to underperform their emerging market counterparts and domestic bonds should offer a higher return than cash for dollar-based investors, according to Robeco.
“Looking ahead, a key question is: are we eyeing the start of a new bull market that will broaden and pave the way for another streak of above-historical excess equity return?” the Robeco team wrote in the report released on Tuesday. “In our base case, we expect developed markets’ earnings growth to end up below current 5Y forward consensus projections, which are high single-digit or even still low double-digit for the U.S. and eurozone.
“The reason we foresee a decline in profitability is linked to our overarching macro theme, the triple power play. Equities will likely bear the brunt of the power play in geopolitics,” according to the report. In addition, efforts by global corporations to shift production toward geopolitically-friendly powers or closer regions “will prove more costly and lower efficiency.” Plus, “further pressure from margins will come from a lagged response from past policy rate hikes.”
Under Robeco’s bull-case scenario, early and rapid adoption of artificial intelligence across sectors and industries would likely spawn above-trend growth and push inflation back to central banks’ targets. The result is “an almost Goldilocks scenario in which things are running neither too hot nor too cold,” central banks could take a break from tightening policy, and developed- and emerging-market equities may both be able to come out with double-digit annualized returns from 2024 to 2028.
The firm’s bear-case scenario envisions a world in which mutual trust between the world’s superpowers hits rock bottom, governments are “in the crosshairs” of central banks, and labor loses bargaining power in the services sector. A “stagflationary environment emerges, intensifying the policy dilemma for central bankers” as inflation stays stubbornly high at 3.5% on average and growth comes in at just 0.5% annually for developed economies. In that situation, developed-market equities would eke out an annualized return of 2.25% for dollar-based investors over the four-year period, which would be below the expected return on cash.
On Thursday, all three major U.S. stock indexes
DJIA
COMP
finished higher as investors digested a batch of better-than-expected U.S. data and continued to expect no action by the Federal Reserve next week. Officials are seen as likely to leave their main policy rate target at a 22-year high of 5.25%-5% on Wednesday.
As investors continued to monitor the possibility of a strike by United Auto Workers, 2-
BX:TMUBMUSD02Y
and 10-year Treasury yields
BX:TMUBMUSD10Y
ended at one-week highs and the ICE U.S. Dollar Index
DXY
jumped 0.6%. In a separate development earlier this week, Air Force Secretary Frank Kendall warned that China is preparing for a potential war with the U.S.
The Dow posted a back-to-back loss on Wednesday after a gauge of consumer inflation for August rose on the back of higher energy costs, while the S&P 500 and Nasdaq Composite ended with modest gains. The Dow Jones Industrial Average
DJIA,
shed about 70 points, or 0.2%, ending near 34,565, according to preliminary FactSet data. That marked its second day in a row of declines. The S&P 500 index
SPX,
added 0.1% and the Nasdaq Composite Index
COMP,
finished at a 0.3% gain. Both the Dow and S&P 500 struggled for direction earlier Wednesday, with both indexes flipping between small gains and loss as investors considered whether the Federal Reserve will be promoted to increase its policy rate any further this year to tamp down inflation further. Its benchmark rate was increased to a 22-year high in July. The consumer price-index for August showed the yearly rate of inflation climbed to 3.7% from 3.2% in July, and up from a 27-month low of 3% in June.
Inflation is likely to fall below the Federal Reserve’s 2% annual target by late next year, according to David Kelly, chief global strategist at JP Morgan Asset Management.
Consumer prices rose again in August to reach a 3.7% yearly rate, based on Wednesday’s release of the monthly consumer-price index. That marked its biggest jump in 14 months and a higher reading than the recent 3% low set in June (see chart) as the toll of the Fed’s rate hikes kicked in.
AllianceBernstein
The catalyst for increased price pressures in August was a roughly 30% surge in energy prices
CL00,
this quarter, according to Eric Winograd, director of developed market economic research at AllianceBernstein.
West Texas Intermediate Crude, the U.S. benchmark, settled at $88.52 a barrel on Wednesday, as traders focused on supply concerns following decisions by Saudi Arabia and Russia to cut crude supplies through year-end. WTI was trading at a low for the year below $65 a barrel in May.
“I don’t think that today’s upside surprise is sufficient to trigger a rate hike next week and I continue to expect the Fed to stay on hold,” Winograd said, in emailed commentary. “But with inflation sticky and growth resilient, the committee is likely to maintain a clear tightening bias—the dot plot may even continue to reflect expectations of an additional hike later this year.”
Federal Reserve officials increased the central bank’s policy rate to a 5.25%-5.5% range in July, the highest in 22 years.
Higher gasoline prices, however, also could act as a counterweight to inflation, according to JP Morgan’s Kelly. “Indeed, to the extent that higher gasoline prices cool other consumer spending, the recent energy price surge could contribute to slower growth and lower inflation entering 2024,” Kelly wrote in a Wednesday client note.
“We still believe that, barring some further shock, year-over-year headline consumption deflator inflation will be below the Fed’s 2% target by the fourth quarter of 2024.”
Kelly isn’t expecting the Fed to raise rates again in this cycle.
U.S. stocks ended mixed Wednesday following the CPI update, with the Dow Jones Industrial Average
DJIA
down 0.2%, the S&P 500 index
SPX
up 0.1% and the Nasdaq Composite Index
COMP
up 0.3%, according to FactSet.
But with oil prices well off their lows for 2023, Winograd said further progress on cooling headline inflation is unlikely this year, even though he expects core inflation to gradually decelerate, a process that will “keep the Fed on high alert.”
Investors were evaluating a less-than-straightforward take on U.S. inflation Wednesday, with August’s consumer price index coming in close to or in line with expectations while providing reasons for the Federal Reserve to hike again by year-end.
U.S. stocks
DJIA
COMP
were higher, though wavering, in New York afternoon trading as traders weighed the chances of another rate hike in November. Three-month through 1-year T-bill rates were up slightly, though 2- through 30-year Treasury yields slipped. And the ICE U.S. Dollar Index
DXY,
which moves according to the market’s expectations for U.S. rates relative to the rest of the world, swung between gains and losses.
Rising gas prices in August had Wall Street anticipating higher headline inflation figures of 0.6% for last month and either 3.6% or 3.7% year-on-year ahead of Wednesday’s session, and on that score August’s CPI report met expectations. The as-expected headline readings appeared to offer some comfort to many investors, even though the monthly gain was the biggest increase in 14 months and the annual rate jumped versus the prior two months.
Still, Ed Moya, a senior market analyst for the Americas at OANDA Corp. in New York, said “this was a complicated inflation report” and price gains are failing to ease by enough for the central bank to abandon its hawkish stance. Core readings which matter most to Fed policy makers came in a bit above expectations at 0.3% for last month, driven partly by a jump in airline fares, as the annual core rate dipped to 4.3% from 4.7% previously. According to Moya, “inflation will likely still be running well above the Fed’s 2% target for the rest of the year.”
“Today’s uptick in CPI could slightly increase the likelihood of a November interest rate hike and potentially delay the timing of any rate cuts until deeper into 2024,” said Joe Tuckey, head of FX analysis at London-based Argentex Group, a provider of currency risk-management and payment services.
As of Wednesday afternoon, however, August’s CPI wasn’t putting much of a dent in expectations for fed funds futures traders. They see a 97% likelihood of no rate hike next Wednesday, which would keep the fed funds rate at between 5.25%-5.5%, and a more-than-50% chance of the same in November and December, according to the CME Fed Tool. They also continued to price in the likelihood of no rate cuts through the early part of 2024.
While August’s CPI report failed to move the needle in stocks, the dollar, or fed funds futures, there was one corner of the financial market where the data did make more a difference: Traders of derivatives-like instruments known as fixings now foresee five more 3%-plus annual headline CPI readings starting in September, after adjusting their expectations to include January.
If those expectations play out, that would bring the total number of 3%-plus readings to six months, including August’s data, and produce a scenario that investors may not be entirely prepared for — the possibility that headline inflation doesn’t meaningfully budge from current levels soon.
Read: Why financial markets may be unprepared for a fourth-quarter ‘inflation surprise’
Central bankers care more about less-volatile core readings, but pay attention to headline CPI figures because of their potential to affect household expectations.
“While these numbers do not change our, and the market’s, expectations that the Fed will hold the target fed funds rate unchanged at the September meeting, the slightly stronger number can influence the tone of the press conference and Summary of Economic Projections,” said Greg Wilensky, head of U.S. fixed income at Denver-based Janus Henderson Investors, which manages $322.1 billion in assets.
“We continue to expect some reduction in the number of participants projecting further hikes, but probably not enough to move the median projection of one more rate hike,” Wilensky said in an email. “That said, we believe that we have likely seen the last rate hike for this cycle, as the economic data that the Fed will see over the coming months will keep them on hold and allow the impact of 5.25% of prior hikes to slow the economy and inflation.”
U.S. stocks closed lower on Tuesday, with the Nasdaq Composite leading the way down, as Apple’s unveiling of its new iPhone and watch failed to boost appetite for equities. The Dow Jones Industrial Average
DJIA,
shed about 16 points, or about 0.1%, to end near 34,647, while the S&P 500 index
SPX,
closed 0.6% lower and the Nasdaq Composite Index
COMP,
slumped 1%, according to preliminary FactSet data. That was the biggest daily percentage drop in about a week for the Nasdaq. Shares of Apple Inc.
AAPL,
were a focus Tuesday as it rolled out a lineup of new consumer products, including its iPhone Pro Max, which will now start at $1,199 instead of $1,099, while its Pro model’s price stays the same. Investors also remain focused on the inflation data, including the release on Wednesday of the consumer-price index for August, before the U.S. stock market’s open. Apple shares fell 1.9% on Tuesday. Climbing bond yields can pressure high-growth stocks as borrowing costs rise. The benchmark 10-year Treasury yield
TMUBMUSD10Y,
edged down 2.4 basis points to 4.263% Tuesday, but was still near its highest level of the year.
Nvidia Stock’s Losing Streak Keeps Going. What Happened to Wall Street’s Darling?
Neuberger Berman, an asset manager with eight decades under its belt, is on the lookout for cracks in credit markets from the Federal Reserve’s rate-hiking campaign.
Erik Knutzen, chief investment officer of multi asset, worries that several factors could be a tipping point for the economy, from an economic slowdown in China to U.S. consumers finally becoming exhausted by higher rates.
Yet Knutzen expects the high-yield, or junk bond, market to serve as the “canary in the coal mine” for broader market volatility, acting as “perhaps the most visible threat, and therefore one we think could be priced in sooner than later.”
The Bloomberg U.S. High Yield Bond Index has returned 6.4% through the end of August, producing one of the year’s highest gains in fixed income, helped along by a “resilient U.S. economy coupled with still-available financial liquidity,” according to the Wells Fargo Investment Institute.
But Knutzen worries that as the high-yield maturity wall draws closer, “the first policy rate cuts get priced further and further out, raising the threat of expensive refinancings.”
The 10-year Treasury yield’s
BX: TMUBMUSD10Y
climb to a multidecade high in August of almost 4.4% left many major U.S. corporations in early September hesitant to borrow beyond 10 years.
Starting next year, some $700 billion of high-yield bonds are set to mature through the end of 2027, with a big slice of the refinancing need coming from companies with riskier credit ratings below the top BB ratings bracket.
Bloomberg, Wells Fargo Investment Institute, Moody’s Investors Service
The two big U.S. exchange-traded funds linked to junk bonds are the SPDR Bloomberg High Yield Bond ETF
JNK
and the iShares iBoxx $ High Yield Corporate Bond ETF
HYG,
both up 1.8% and 1.5% on the year through Monday, respectively, while offering dividend yields of more than 5.8%, according to FactSet.
Of note, fixed-income strategists at the Wells Fargo Investment Institute also said they see risks emerging in junk bonds for companies rated B and below, particularly with spread in the sector trading less than 400 basis points above the risk-free Treasury rate since July. Spreads are the premium that investors are paid on bonds to help compensate for default risks.
Top corporate executives appear hopeful that the Federal Reserve will cut rates sooner than later. Fed Chairman Jerome Powell said in Jackson Hole, Wyo., in August that the central bank is prepared to keep its policy rate restrictive for a while to get inflation down to its 2% target.
To that end, Neuberger Berman, which has roughly $443 billion in managed assets, sees several sources of volatility lurking through year’s end, and has a “defensive inclination” in equity and credit, favoring high-quality companies with plenty of free cash flow, high cash balances and less expensive long-term debt.
U.S. stocks booked gains on Monday after a week of losses, with the S&P 500 index
SPX
and Nasdaq Composite Index
COMP
scoring their best daily percentage gains in about two weeks. The Dow Jones Industrial Average
DJIA
advanced 0.3%.
Recent weakness in the U.S. stock market is likely to persist over the near-term, according to Wall Street’s most bullish strategist, who still thinks the S&P 500 is on a path to a record high this year.
John Stoltzfus, chief investment strategist at Oppenheimer Asset Management Inc., in late July projected the S&P 500 would rise above 4,900 by the end of 2023. That is the highest price target for the large-cap index among 20 Wall Street firms surveyed by MarketWatch in August.
It implies the S&P 500 would rise above its earlier closing record high of 4,796 reached on Jan. 3, 2022 by the end of the year. The path up, however, could get bumpy.
“Bullishness [in the stock market] is relatively high while the Fed remains shy of its inflation target,” said a team of Oppenheimer strategists led by Stoltzfus in a Sunday note. They also said, “we persist in suggesting that investors curb their enthusiasm [in the stock market] for a long rate pause or even a rate cut and instead right-size expectations.”
Expectations that the Federal Reserve is nearing an end to its current interest-rate hiking cycle, as well as optimism around artificial intelligence boosted the U.S. stock market in the first seven months of 2023. However, the rally came to a brief halt in August as investors worried the Fed could be forced to keep rates elevated as a batch of stronger-than-expected economic data and rising oil prices fueled concerns that still-sticky inflation would mean that borrowing costs will stay higher for longer.
Investors should not brush off those pressures, even through the Fed appears to be nearing the end to its current rate-hike cycle, Stoltzfus and his team said. “The stickiness evidenced in food, services, energy and other prices warrants the Fed remaining vigilant along with a potential for one more hike this year and perhaps another next year,” they said.
See: When will consumers stop buying more stuff? It’s a key question for the stock market.
However, Stoltzfus doesn’t see current headwinds for stocks as something that would prevent the S&P 500 from achieving his team’s new peak target.
Stock-market investors expect this week’s August inflation report to offer more clarity on whether the central bank will continue to ratchet up its fight against inflation. The headline component of the consumer-price index is forecast to accelerate to 0.6% in August from July’s 0.2% gain, while the core measure that strips out volatile food and fuel costs is expected to rise a mild 0.2% from a month earlier, according to a survey of economists by The Wall Street Journal.
Meanwhile, a key Wall Street volatility index also pointed to “some choppiness” in the stock market in the near term to keep investors on their toes, said Stoltzfus. The CBOE Volatility Index
VIX,
at a level of 13.82 on Monday, hovered around its 12-month low and traded about 30% below its one-year average level of 19.9, and 37% below its two-year average of 21.88 (see chart below).
Stoltzfus and his team suggest that investors use market weakness to seek out “babies that get thrown out with the bath water” in periods of volatility. They said the S&P 500 Energy Sector
XX:SP500.10
looks increasingly attractive as policy makers in the U.S. and abroad strive to contain inflation and manage economic growth.
“We believe that prospects are looking better that the Fed’s success thus far in bringing down the rate of inflation could lead to a [rate] pause next year, thus lessening pressures on economic growth,” the strategists said. An improved economic growth, along with fiscal stimulus from investment in stateside infrastructure projects and stateside chip manufacturing efforts, could contribute to profitability in the energy sector into 2024, the team added.
The Energy Select Sector SPDR Fund
XLE,
which is seen as a proxy of the energy sector of the S&P 500, has advanced 3.9% year to date versus a 8.5% increase in the price of the U.S. benchmark West Texas Intermediate crude oil
CL00,
CL.1,
according to FactSet data.
Oil futures
CLV23,
BRNX23,
traded at their highest levels of the year on Monday morning, a week after Russia and Saudi Arabia caught markets off guard with their output cut extension announcements, but they settled modestly lower on Monday afternoon.
See: Energy ETFs are outshining the S&P 500, but it’s not just because of the oil rally
Stoltzfus in late July projected the S&P 500
SPX
would rise above its record high by the end of 2023, lifting his year-end price target for the large-cap index to 4,900 from an earlier 4,400 projection from December. It implies a 9.2% advance from where the S&P 500 settled on Monday, at around 4,487.
U.S. stocks finished higher on Monday, boosted by technology shares as Nasdaq Composite
COMP
advanced 1.1%. The S&P 500 was up 0.7% and the Dow Jones Industrial Average
DJIA
ended 0.3% higher, according to FactSet data.
The fortunes of
Apple
the world’s largest public company, have a tendency to lead around much of the rest of the stock market. After the tech giant’s woes contributed to widespread declines last week, investors can now breath…
U.S. stocks finished modestly higher on Friday, but Wall Street still suffered a losing week amid renewed concerns that the Federal Reserve may keep interest rates higher for longer. The S&P 500
SPX,
booked a 1.3% weekly loss, while the Dow Jones Industrial Average
DJIA,
fell 0.8% and the Nasdaq Composite
COMP,
dropped 1.9% for the week. All three major indexes logged their worst weekly decline since August 18, according to Dow Jones Market Data. Meanwhile, investors looked ahead to inflation data, with readings on the consumer-price index and producer-price index next week expected to offer further clues on the central bank’s rate decision at its next policy meeting.
August was a hot month and it wasn’t just about the weather. Financial markets are now bracing for what’s likely to be a rebound in headline U.S. inflation next week, fueled by higher energy prices.
Barclays
BARC,
BofA Securities
BAC,
and TD Securities expect August’s consumer price index to reflect a 0.6% monthly rise, up from the 0.2% monthly readings seen in July and in June. In addition, they put the annual CPI inflation rate at 3.6% or 3.7% for last month, which compares with the 3.2% and 3% figures reported respectively for the prior two months.
While Federal Reserve policy makers and analysts are loath to read too much into one report, August’s CPI has the potential to disrupt expectations that getting back to the central bank’s 2% target will be easy. Inflation has instead been nudging back up since June, with the likely rebound in August being regarded as primarily driven by the energy sector. What now remains to be seen is how much longer energy prices will remain elevated and whether they’ll begin to feed into narrower measures of inflation that matter most to the Fed.
Read: Stock-market investors just got reminded that the inflation fight isn’t over
“We’re going to see a spike in gas prices and other commodity prices driven by supply cuts, which means headline CPI goes back up,” said Alex Pelle, a U.S. economist for Mizuho Securities in New York. Via phone on Friday, Pelle said that prospects for a hotter August CPI report have already been factored in by financial markets, with all three major U.S. stock indexes heading for weekly losses.
How investors react to next Wednesday’s data will likely come down to whether the rebound in headline figures is seen as “a one-off” or something that gets repeated, and “what that means for the bottoming off of inflation,” Pelle said. “The equity market is going to have some trouble in the fourth quarter after a pretty impressive first half. Earnings expectations are still pretty high, but the macro-driven backdrop is challenging.”
Rising energy prices in August have already spilled into the month of September, with gasoline reaching the highest seasonal level in more than a decade this week. Voluntary production cuts by Saudi Arabia and Russia are a major contributing factor curtailing the supply of crude oil into year-end, and Goldman Sachs has warned that oil could climb above $100 a barrel.
In financial markets, there’s one group of traders which is telegraphing that the final mile of the road toward 2% inflation won’t be smooth.
Traders of derivatives-like instruments known as fixings anticipate that the next five CPI reports, including August’s, will produce annual headline inflation rates above 3%. Though policy makers care more about core readings that strip out volatile food and energy prices, they’re aware of how much headline figures can impact the public’s expectations.
At BofA Securities, U.S. economist Stephen Juneau said August’s CPI won’t necessarily change his firm’s view that inflation is likely to move lower next year and fall back to the Fed’s target without the need for a recession. BofA Securities expects just one more Fed rate hike in November and will maintain that view if August’s CPI report comes in as he expects, Juneau said via phone.
After stripping out volatile food and energy items, BofA Securities, along with Barclays and TD Securities, expects August’s core CPI readings to come in at 0.2% month-over-month — matching June and July’s levels — and to fall to 4.3% on an annual basis.
Based on core measures, August’s report wouldn’t “change the narrative all that much: Everything points to a moderation in price growth,” Pelle said. “There’s a reason why food and energy are typically excluded,” and “we don’t want to put too much stock into one month.”
As of Friday afternoon, all three major U.S. stock indexes were headed higher, with the S&P 500 attempting to snap a three-day losing streak. Dow industrials
DJIA,
the S&P 500
SPX
and Nasdaq Composite
COMP
were respectively on track for weekly losses of 0.7%, 1.2%, and 1.7%. They’re still up for the year by more than 4%, 16% and 31%.
Meanwhile, Treasury yields turned were little changed on Friday as fed funds futures traders priced in a 93% chance of no action by the Fed at its next policy meeting in less than two weeks, and a more-than-50% likelihood of the same for November and December — which would leave the Fed’s main policy rate target between 5.25%-5.5%.
“There is a risk that investors are too complacent about the inflation report,” said Brian Jacobsen, chief economist at Annex Wealth Management in Elm Grove, Wis. “We might not get to 2% inflation as quickly as many hope.”
U.S. stocks finished mostly lower on Thursday with the Nasdaq Composite leading the way down as investor sentiment cratered in the face of concerns that the Federal Reserve may keep interest rates higher for longer. The technology-heavy Nasdaq
COMP,
fell 123 points, or 0.9%, to end at 13,748, while suffering its four consecutive sessions of losses. The Dow Jones Industrial Average
DJIA,
was up 0.2%, and the S&P 500
SPX,
dropped 0.3%. Apple shares
AAPL,
were down for a second day, after the Wall Street Journal reported that China had banned government officials from using iPhones for work purposes. In U.S. economic data, initial jobless benefit claims fell by 13,000 to 216,000 in the week ended Sept. 2, the U.S. Labor Department said Thursday. This is the lowest level since mid-February.
Central bankers like to focus on core inflation readings, which strip out food and energy prices, but that doesn’t mean that they, or investors, will be able to ignore a renewed surge in crude-oil prices.
In a Thursday note, DataTrek Research observed that the correlation between energy prices and the core reading of the consumer-price index has returned to levels seen in the 1970s and 1980s. It stands at 0.62 since 2020, compared with an average of 0.68 in those prior decades, and well above its long-run average of 0.31. A reading of 1.0 would mean the measures were moving in perfect lockstep. (See table below.)
Core measures of inflation typically strip out volatile items like food and energy. While that often leads to eye-rolling by commentators who note that food and energy make up a big chunk of what consumers spend money on, the logic behind the move holds that such items are less responsive to monetary policy.
Policy makers put more emphasis on the core reading for a better read on what they can influence. The core personal-consumption expenditures, or PCE, index, for example, is often described as the Federal Reserve’s favored inflation indicator.
But that doesn’t mean rising energy or food prices can be ignored. Energy, after all, is an input, and can have an influence on overall prices.
“Recent data says energy prices hold more sway on core inflation than any time since the 1970s/1980s, so rising oil prices are a legitimate concern for both the Fed and capital markets. Food inflation fits the same bill,” said DataTrek co-founder Nicholas Colas in the note.
Oil prices have been on a tear this summer, with the rally accelerating after Saudi Arabia announced earlier this week it would extend a production cut of 1 million barrels a day through the end of the year, with Russia also pledging to extend a supply cut.
West Texas Intermediate crude
CL00,
the U.S. benchmark, extended a winning streak to nine days on Wednesday, while Brent crude
BRN00,
the global benchmark, rose for a seventh straight day. Both grades ended at 2023 highs Wednesday before pulling back modestly in the Thursday session.
The surge in crude threatens to further drive up fuel prices, including gasoline and diesel.
And rising oil prices this week got a chunk of the blame from investors and analysts for a pickup in Treasury yields as market participants began to pencil in a longer stretch of higher interest rates — or weighed the possibility the Fed may need to deliver more monetary tightening. That’s also contributed to a rise in the U.S. dollar, with the ICE U.S. Dollar Index
DXY,
a measure of the currency against a basket of six major rivals, hitting a six-month high.
U.S. stocks have weakened in the face of rising yields, with technology and growth shares, which are particularly rate-sensitive, leading the way lower. The Nasdaq Composite
COMP
was on track for a 2% decline so far this holiday-shortened week, while the S&P 500
SPX
has pulled back 1.4% and the Dow Jones Industrial Average
DJIA
has lost 1%.
“With oil prices rising again, we got to wondering about the spillover effects of this move on inflation. Will pricier crude derail recent disinflationary trends?” Colas wrote.
Another big corporate borrowing blitz to kick off September has gotten under way, but this one isn’t looking like the rest.
Instead, the flurry of new bond issues shows how the Federal Reserve’s higher interest rate environment has begun to seep in a year later, by making major companies far more hesitant to tap credit for longer stretches.
“The…
U.S. stocks finished lower Wednesday, with shares of technology companies dropping sharply, as the S&P 500 booked back-to-back losses amid a rise in Treasury yields. The Dow Jones Industrial Average DJIA fell 0.6%, while the S&P 500 SPX dropped 0.7% and the tech-heavy Nasdaq Composite COMP sank 1.1%, according to preliminary data from FactSet. Information technology was the S&P 500’s worst-performing sector on Wednesday with a loss of around 1.4%. In the U.S. bond market, the yield on the 10-year Treasury note rose for a third straight day on Wednesday to 4.289%, according to Dow Jones Market Data.
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