/perspectives/weekly-viewpoint/fed-likely-to-move-by-another-75-basis-points

Fed Likely to Move by Another 75 Basis Points

The major market indices finished the week higher, with the tech-heavy Nasdaq Composite leading the way, as the better-than-feared start to second quarter earnings season drove the ‘buy the dip’ mentality.

July 25, 2022    |    By Michael Schwager

Performance for Week Ending 7.22.2022:

The Dow Jones Industrial Average (Dow) finished up 1.95%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 2.76%, the Standard & Poor’s 500 Index (S&P 500) gained 2.55% and the Nasdaq Composite Index (NASDAQ) tacked on 3.33%. Sector breadth was positive with 8 of the 11 S&P sector groups closing higher. The Consumer Discretionary (+6.79%) led the advance followed by Materials (+4.14%) and Industrials (+4.11%). On the downside, Communication Services (-1.16%) was the worst performer.

Index* Closing Price 7/22/2022 Percentage Change for Week Ending 7/22/2022 Year-to-Date Percentage Change Through 7/22/2022
Dow 31899.29 +1.95% -12.22%
Wilshire 5000 39472.44 +2.76% -18.55%
S&P 500 3961.63 +2.55% -16.88%
NASDAQ 11834.11 +3.33% -24.36%

*See below for Index Definitions

 
MARKET OBSERVATIONS: 7/18/22 – 7/22/22

The major market indices finished the week higher, with the tech-heavy Nasdaq Composite leading the way, as the better-than-feared start to second quarter earnings season drove the ‘buy the dip’ mentality. Despite the gains in the headline indices, last week’s trading activity was generally lackluster due to seasonal factors and as many investors remain tethered to the sidelines ahead of this week’s much anticipated Federal Open Market Committee (FOMC) meeting. The solid gains in the face of light volume suggests that investors may still lack full conviction that the market bottom is in. While still elevated, inflation concerns have lessened as commodity prices have weakened in recent weeks. The price of WTI crude oil has fallen into a bear market (down 23.4% since the March 8 peak) while gasoline prices have retreated by $0.65/gallon since the mid-June peak. Elsewhere, prices for lumber, copper, and corn are all off sharply from their recent highs. The decline in commodity prices coupled with weakened economic trends has resulting building anticipation that the Fed may have to curtail its tightening program sooner than initially thought.

All eyes will be on this week’s two day FOMC meeting. With the June consumer price index showing a 9.1% year-over-year increase, the Fed is expected to hike rates on Wednesday by another 75 basis points (bps). The combined increase of 150bps over June and July would represent the steepest rise in Fed rates since the early 1980s when Paul Volcker was Fed chairman and battling sky-high inflation. Despite some recent chatter, there appears to be little appetite for a full-point (100 bps) rate increase. Last week, Fed Governor Christopher Waller, one of the more hawkish policy makers, endorsed a 75 basis-point move, and Atlanta Fed President Raphael Bostic warned that moving too dramatically would have negative spillover effects. The Fed is seeking to cool off economic demand in response to surging prices that have persisted longer than expected, raising concern that inflation expectations could become unhinged. The Fed will really need to stick the needle with its after meeting statement where they will need to affirm their determination to crush inflation while not being too hawkish and further spooking the market.

Q2 Earnings Season: While it still remains early in the reporting season, second quarter results are off to an encouraging start. Through Friday, 104 members of the S&P 500 have reported results with 72% surprising to the upside. Overall reported earnings for the S&P are currently off about 6%, but the bulk of the weakness has been concentrated in the Financials sector, which has seen year-over-year earnings decline by 27%. Best results are coming from the Industrials, Energy, and Consumer Discretionary sectors. When all is said and done, S&P 500 second quarter earnings are expected to rise by 5.5%, however, ex-Financials earnings are forecast to grow by 12.7%.

Market View: Our cautiously optimistic view on the markets remains intact, although we do recognize that storm clouds in the form of persistently hot inflation and tighter monetary policy have somewhat darkened the outlook. While there is a chance that the Fed will be able to bring the economy to a soft landing, we do acknowledge rising downside risks and that the Fed faces an increasingly difficult task as it tries to balance inflation and recession worries. On a positive note, equity valuations have retreated during the first half of the year, suggesting a lot of negative news and uncertainty has already been discounted in the markets.

With inflation levels running at the highest pace in four decades, the Fed has been raising interest rates in an effort to cool price increases while at the same time knowing that the more aggressive they hike rates, the higher the probability that the economy falls into a recession. In his recent twice annual testimony to the House and Senate panels, Fed Chairman Powell suggested that fighting inflation is now job one, even if it ultimately leads to a contraction in the economy. The problem however is that monetary policy is a very blunt tool that generally operates with about a one-year lag. In other words, near-term rate hikes won’t fully work their way through the economy until the middle of next year. In addition, monetary policy is best used to cool high levels of demand, however, the issues driving inflation are mostly due to Covid related supply chain issues and the Ukraine/Russia war, events that are immune from higher interest rates.

The Week Ahead: The Fed's decision on Wednesday will be the focal point for markets this week with consensus expectations of a 75bps rate hike. Investors will also likely focus on the trajectory and magnitude of hikes in the subsequent meetings after the stronger than expected June CPI data. On Thursday, investors will turn their attention to the first Q2 GDP reading for the US. Concerns about a material slowdown have negatively impacted markets and ignited fear of a second reading of negative GDP in a row. Although two consecutive quarters of negative GDP growth would mean recession by the general definition, whether the NBER (the official arbiter of recession dating) decides to label it so is unclear. According to Bloomberg, economists are forecasting economic growth of +0.5%, although this is in sharp contrast to the Atlanta Fed’s GDP-Now model, which is predicting a contraction of 1.59%. Second quarter earnings season will also be front and center with 166 members of the S&P 500 expected to release results. While earnings will be watched very closely, more importantly will be what company management has to say about the second half of the year in light of slowing economic growth, supply chain disruptions, and soaring levels of inflation.

Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500© Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

This material contains opinions of the author, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. No part of this material may be reproduced or referred to in any form, without express written permission of Guggenheim Partners, LLC.




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