Hawkish comments by Fed Chairman Powell sink stocks

One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute. – William Feather, was an American publisher and author

As expected, the Federal Reserve raised the federal funds interest rate by 0.75 of a percentage point last week, but it was comments after the meeting by Fed Chairman Jerome Powell that sank the stock market. After surging 14% in October and posting its best month since January 1976, the Dow Jones Industrial Average gave back 1.4% last week while the technology-laden Nasdaq Composite Index was clobbered, plunging 5.7% as higher bond yields took their toll on more expensive growth stocks. The S&P 500 Index split the difference between those two stock averages and ended the week with a loss of about 3.5%.  Initially, the stock market rose on Wednesday following the Fed’s announcement but turned negative during Powell’s press conference when he said that the so-called “terminal” federal funds rate, or the level at which rates peak, would be higher than the Fed previously thought. The 75-basis point increase (a basis point is one hundredth of one percent) brings the federal funds rate to a range of between 3.75% and 4%, the highest level since January 2008, after starting the year slightly above zero. Two regional Fed presidents echoed Powell’s comments by saying that more interest rate hikes are needed, but maybe at a slower pace with longer duration and a potentially higher terminal rate. Economists now see only a half a point increase at the Fed’s meeting in December and then a few smaller hikes in 2023. Concerns have risen that higher interest rates aimed at reducing inflation could tip the economy into a recession, but Powell also said that a soft landing with no severe contraction is still possible even though the path to one has narrowed and could be harder to achieve. Although the October employment report released on Friday showed an increase of a better-than-expected 261,000 jobs, the unemployment rate increased to 3.7% from 3.5% and wage growth decelerated. It was the slowest pace of job gains since December 2020 and stocks rallied as the bad news was perceived as good news by investors since the Fed might be inclined to slow its monetary tightening.

Last Week

Other jobs data last week was stronger than expected as ADP reported that 239,000 private sector jobs were created in October, higher than estimates, and the weekly jobless claims totaled 217,000, lower than in the previous week and below estimates. The September Job Openings & Labor Turnover Survey (JOLTS) showed far more job openings than expected, equating to 1.9 job openings for every available worker and a sign that the labor market remains tight. The ISM manufacturing index in October was slightly better than expected while the ISM services sector index was less than expected and the lowest reading since May 2020. Both indices were still above the 50 level that indicates expansion.

For the week, the Dow Jones Industrial Average fell 1.4% to close at 32,403 while the S&P 500 Index lost 3.4% to close at 3,770. The Nasdaq Composite Index plunged 5.7% to close at 10,475.

This Week

The consumer price index (CPI) for October is expected to show an increase of 8% year over year while the core CPI that excludes food and energy prices is forecast to increase 6.5%, slightly less than in the previous month.

The bond market is closed on Friday in observance of Veterans Day, but the stock market will be open.

Among the most prominent companies scheduled to report third quarter earnings this week are BioNTech, AstraZeneca, Becton Dickinson, Constellation Energy, Occidental Petroleum, DuPont, Walt Disney, International Flavors & Fragrances, D.R. Horton and Rivian Automotive.

Portfolio Strategy

There were signs last week in the October employment report that the labor market might be cooling off and this week the October consumer price index (CPI) will be watched closely for signs that inflation might be easing as well. Prior to their next Federal Open Market Committee (FOMC) in mid-December, the Fed officials will also be able to review November jobs and inflation data and decide how much to raise interest rates. The market is pricing in a 50-basis point increase now, but another 75-basis point hike is possible depending on the data. The Fed has two objectives – to support maximum employment and to maintain price stability – and with the labor market holding up well, the focus has been entirely on reducing high inflation. The Fed’s determination to bring inflation under control has been reflected in the Treasury market where the 2-year Treasury yield has climbed to 4.70% and the 10-year Treasury yield has risen to 4.15%. The other important event this week is the midterm elections on Tuesday that will determine which party controls Congress for the next two years. Right now, polls suggest that the Republicans will retake the House of Representatives while the Senate is too close to call.  History favors the Republicans, especially since President Joe Biden has one of the worst approval ratings of any sitting presidents heading into the midterms. The markets generally prefer divided or split government since any significant legislation and fiscal spending plans have little chance of passing. There is less risk to certain controversial sectors such as energy and health care and it means fewer policy changes. But it also raises the possibility of a government shutdown and the inability to raise the debt ceiling, leading to gridlock and a government that doesn’t work for anyone.