Fed Raises Rates as Earnings Season Continues
- JOLTS numbers emphasize tight labor market
- Bausch + Lomb IPO priced
- ISM reports both manufacturing and services data
- Raytheon averts work stoppage
- DuPont and BorgWarner beat consensus
- And much, much more!
Fed Raises Rates
The U.S. Federal Reserve voted to increase its benchmark interest rate by 50 basis points (0.50%) in order to counter inflationary pressures. According to Chairman Jerome Powell: “Inflation is much too high. And we understand the hardship it is causing, and we’re moving expeditiously to bring it back down. We have both the tools we need and the resolve that it will take to restore price stability.” The target range for the benchmark federal-funds rate is now 0.75%-1.00%. Additionally, the Fed said they would start to shrink their $9 trillion balance sheet by allowing bonds held to mature without reinvesting the proceeds into new securities. They will allow $30 billion in Treasury bonds and $17.5 billion in mortgage-backed securities to mature without reinvestment in June, July and August. Then they will allow $60 billion of Treasurys and $35 billion of mortgage bonds to run off every month subsequently.
How does the current Fed tightening compare to previous periods? Between 2004 and 2006, the Fed raised its benchmark rate by 4.25 percentage points to a peak of 5.25%. Between 2015 and 2018, Fed officials raised rates from near zero to a range between 2.25% and 2.5%. So, when will they stop this time? Many projections believe it will be when the target range gets near 2.75% to 3.00%. That means we have a long way to go before that happens. As we have discussed in the past two quarterly commentaries (available in the password-protected vault on our website), this is a period of transition. The Fed is in full hike mode and the sooner the market accepts that fact, the better. It is now clear that they are “behind the curve” in terms of inflation because they underestimated how quickly supply-chain issues would be fixed and the invasion of Ukraine by Russia has only exacerbated the problem. But they are caught between a rock and a hard place. Do nothing and the 40-year high inflationary figures get even worse which would mean the pain needed to control prices in the future would be immense. Raise rates now and at least begin to put a cap on the issue but whether it’s now or later, patients do not like to take the medicine!
The labor market is one of the key points of focus and maintaining full employment is one of the Fed’s mandates. According to the Labor Department’s Job Openings and Labor Turnover Survey, job openings and number of times workers quit reached record highs. There were a seasonally adjusted 11.5 million job openings in March, an increase from 11.3 million in February and up a notch from the 11.4 million in December 2021 which was the previous record. The number of times workers quit their jobs in March rose to 4.5 million, slightly higher than the previous record in November of 2021. Therefore, there is a gap between the 11.5 million job openings and 6 million unemployed but seeking work which is putting upward pressure on wages. Manufacturing, retail, education and professional services are the industries which have seen the largest job postings in the past few months. The coronavirus sidelined millions either due to fear of contracting the disease or childcare responsibilities, and, at this point, it is anyone’s guess when or if they will return.
Today, monthly nonfarm payroll data for the month of April was released. According to the Labor Department, payrolls rose 428,000 which matched the gain in March while the unemployment rate held at 3.6%. The median estimate in a Bloomberg survey of economists predicted a 380,000 advance in payrolls so the actual amount came in above expectations. Average hourly earnings were up 5.5% from a year earlier as extreme competition for workers as highlighted above is pushing compensation trends higher. The labor force participation rate measures the share of the population that is working or looking for work. That number dipped to 62.2%, the lowest in three months. This is not the trend the Fed wanted to see because more workers means less pressure to increase wages to attract candidates. Investors will be keenly watching this figure to see if the trend reverses in the months ahead or if more people are merely quitting or retiring and simply will not be going back to work in the foreseeable future.
The Institute for Supply Management released manufacturing and services data this week for the month of April. Manufacturing activity fell last month to the lowest level since 2000. A reading of 55.4 was down from 57.1 in March. Levels above 50.0 are considered expansionary, but it was still below the median projection in a survey of economists of 57.6. Supply-chain issues continue to weigh on production data as lead times for capital equipment grew to 173 days, matching the highest in data back to 1987. Meanwhile, the services index came in at 57.1 last month, a decrease from 58.3 in March. A gauge of new orders growth pulled back to the softest pace since February of last year while. For both manufacturing and services, employment activity fell underscoring the ongoing challenge of finding candidates to hire.
So how did the markets react to the Fed change? The major averages leaped higher with the S&P, Dow Jones Industrial Average and Nasdaq Composite each higher by about 3% when the normal trading session closed on Wednesday. Is that an all-clear signal? Hardly, as the very next day these same averages were down even more as those one day gains evaporated in a flash. The reason for the rise on Wednesday was mostly fueled by the fact that Mr. Powell said that a 75 basis point move was not under consideration at the moment which translated into an equity relief rally. A larger move by the Fed would be a sure signal that things were really spiraling out of control on the inflation front. Moreover, the Fed’s balance sheet decision meant the committee was still “stealth tightening” even though they were not using interest rates directly to do it. The balance sheet plan was in-line with what had been rumored weeks ago which meant it was not a surprise and investors were cheered by it.
A rising interest rate also means that items priced in dollars become more expensive to those overseas. With nearly 40% of S&P 500 sales from international operations, we are increasingly hearing on the quarterly conference calls how much of a headwind this is becoming. The conflict in Europe means that some sort of economic slowdown is all but certain there adding to global woes. Investors are beginning to price in this reality which is another reason why stocks have had a difficult year and potentially more pain in now being priced in by traders. Days like Thursday’s drubbing and the negative tone today heading into the weekend, ironically, do not make investors happy but are what long-term shareholders want to see. While it still might be a stretch to call it indiscriminate selling, there is some irrationality being displayed when companies who have just discussed a solid most recent quarter get slammed simply because everything else is getting slammed. This highlights that markets often trade on emotion, pushing fundamentals to the side in the stampede for the door. Nervousness is a reasonable reaction for reasonable investors, but panic is never a plan. When the call is “get out of the markets at all cost,” it is quite often the wrong call but does mark a crescendo in selling with hopefully brighter days to come once the liquidations are done.
The market’s direction will be set by how aggressive the Fed gets over the coming months. That is dependent upon how inflation behaves. It will be a challenge. The Fed can control demand directly through rates which indirectly affects how expensive things gets. But it cannot control supply chain shocks. “There’s a path by which we would be able to have demand moderate in the labor market” without causing a recession, Mr. Powell said. He later added: “It’s not going to be easy. And it may well depend, of course, on events that are not under our control.” Out of 13 previous rate hike cycles, the Fed was able to achieve the coveted “soft landing” in 3 of them. That is less than a quarter of the time. The good thing is that Chairman Powell and his colleagues have the prior experiences to draw upon to shape their strategy and responses, and they are going to need every bit of it to achieve their goal. Stay tuned.
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