Stock index futures fall as Fed puts…
Stock index futures fell overnight after the Swiss National Bank announced a surprise rate hike and the Bank of England raised its rate for the fifth consecutive time.
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Key points to remember
Stock index futures fall as Fed rate hike puts other central banks on the defensive
Stocks rallied ahead of Wednesday’s Fed announcement but failed to sustain a rally through the close
- Can value stocks withstand higher rate expectations?
Shawn Cruz Director of Derivatives Strategy, TD Ameritrade
(Thursday Market Open) While Americans slept on the Fed’s rate hike, the Swiss National Bank (SNB) announced a surprise hike in its key rate and the Bank of England (BoE) also raised theirs. With central banks around the world now raising rates, stock index futures have fallen dramatically with S&P 500 Futures Contracts down more than 2.3% before the opening bell.
Market potential movers
The SNB’s rise is its first since 2007, taking its benchmark index from -0.75% to -0.25%. The SNB also raised its inflation forecast for 2022 to 2.8% from 2.1%. However, he maintained his economic forecast at 2.5% growth.
The BoE was the first of all central banks to start raising rates and this morning’s hike was its fifth in a row. The quarter-point increase took the BoE’s key rate to 1.25%. However, three BoE board members voted to raise the rate by 50 basis points.
With three central banks raising rates in less than 24 hours and the European Central Bank (ECB) calling for a surprise meeting, this not only paints a far worse picture of inflation than global banks had originally expected, but reflects also the need for central banks to protect their currencies from the strength of the US dollar. As the global economic situation deteriorated, investors fled to greenbacks and Treasuries as a safe haven and reduced liquidity in other countries. Rising rates are likely to induce a recession, but rising inflation and the Fed are forcing other central banks to raise rates.
While the SNB may have prompted the sell-off, the pullback in equities is closer to what you might have expected from the Fed’s 75 basis point hike instead of yesterday’s relief rally. The Cboe Market Volatility Index (VIX) rose over 6% before the opening bell, climbing well above 31. When the VIX is above 30, nothing good is happening and when the VIX is above 40, only bad things happen.
More negative US economic news arrived this morning with building permits down 7% in May and housing starts down 14.4%. The results reflect continued weakness in the housing market and in particular new homes. The Philadelphia Fed’s manufacturing index came out at -3.3, a sign that economic conditions are deteriorating. Analysts expected the report to come in at 5.5. Finally, first jobless claims were also higher than expected.
Earnings of Kroger (KR) beat both revenue and net income figures and the grocer raised its full-year profit forecast. However, the stock fell 4.4% in premarket trading following news of a slight drop in the company’s same-store sales forecast. The supermarket chain has done a fairly good job of managing inflation although the company has tightened its earnings forecast range, which may reflect new purchasing contracts that could help them fix some costs and lower them. protect against inflation.
Market Minutes Review
The Federal Reserve met the consensus on Wednesday with a 75 basis point rate hike that will take the federal funds rate to a range between 1.5% and 1.75%. Fed Chairman Jerome Powell told reporters afterwards that the 75 basis point hike is unlikely to be a routine increase and that the Fed will likely hike 50 to 75 basis points in July and then return to increases in the 25-50-basis point range thereafter.
Mr Powell warned that any future moves will depend on data, and the Fed’s dot chart revealed that every member of the Fed sees the central bank’s overnight rate hitting 3% by the end of the month. 2022 with an average projection of 3.4%.
Notably, the Fed chose not to change its plans to unload its balance sheet. In fact, during the day, the Fed began its $9 trillion balance sheet reduction by allowing $15 billion of Treasuries to mature without replacement. During the remainder of June, the Fed plans to offload a total of $30 billion in Treasuries and $17.5 billion in mortgage-backed securities. The amount of quantitative tightening (QT) will increase over the next three months at a monthly pace that will eventually reach $60 billion in Treasuries and $35 billion in mortgage-backed securities.
The problem with QT is that it can add more volatility to an already volatile Treasury market. The Treasury market and the mortgage market are now losing one of their biggest customers and will have to rely on other institutions and investors to pick up the slack. Those replacing Fed business could demand a higher rate of return, which could push yields even higher.
The Fed also adjusted its unemployment outlook upward, with Powell noting that executing an economic “soft landing” has become increasingly difficult. The Fed cut its 2022 gross domestic product (GDP) to 1.7% from 2.8%. Powell added that the central bank hopes unemployment will not rise above 4.1% as rates do their job of slowing the economy.
The shares rose during the morning and, with most of the surprises already priced in, they remained relatively unchanged after the announcement. After the press conference, the shares attempted to stage another rally but were turned away. Nevertheless, the S&P500 (SPX) ended the day 1.46% lower, while the Nasdaq Compound ($COMP) climbed 2.5% and closed higher for the second day in a row. The Dow Jones Industrial Average ($DJI) increased by 1%. The 10-year Treasury yield (TNX) was also little changed after falling this morning from Tuesday’s high and finished at 3.395%.
Three things to watch out for
Lasting value? As yields rose in anticipation of and in response to Fed rate hikes, investors turned to value stocks to grow or maintain their portfolios. The S&P 500 Pure Value Index shows that investors who bought value stocks have likely maintained the value of their portfolios, as the index has oscillated in a sideways trend since May 2021. In contrast, the S&P 500 Pure Growth Index has been declining since November. Now that the Fed is feeling the pressure to be more aggressive, will this trend continue?
The value index is still showing relative strength against the growth index, suggesting that value is likely to outperform growth. However, that doesn’t mean that value stocks won’t fall as interest rates rise. We saw it starting last week when the value index fell nearly 10% in four days.
Valuing the value: As interest rates rise, fundamentally-focused investors will use their valuation model to determine a stock’s intrinsic price. Value stocks tend to be less affected by these new valuation models, but they are still discounted, which reduces their intrinsic value in ways that can lower their stock price.
Another benefit of many value stocks is that they often pay dividends, many of which offer higher yields than mid-growth stocks and even the S&P500 (SPX). However, the Dow Jones US Select Dividend Index fell more than 10% last week.
Hiking map: The Fed’s projection of an overnight rate reaching 3.4% by year-end is nearly in line with the market. The 2-year Treasury yield, generally most in line with the Fed’s overnight rate, which closed at 3.21% on Wednesday, down from 3.43% on Tuesday. Trying to break down market projections is a bit tricky. However, the market seems to be right as the Fed still seems to be behind the curve.
With so much change in the global economy, it’s hard to determine where the Fed will end up going with rate hikes. Although the probabilities from the CME tool FedWatch are also subject to change, they provide a reading of what the market expects. Currently, the tool projects 75 basis points in July, 75 in September, 50 in November and 50 in December.
Notable Calendar Items
June 20: Market closed for the holidays of June 16
June 21st: Sales of existing houses
June 22: Earnings from KB Home (KBH) and HB Fuller (FUL)
June 23: Initial jobless claims, US manufacturing PMI and earnings from FedEx (FDX), Accenture (ACN) and Darden Restaurants (DRI)
June 24: Michigan Consumer Sentiment, New Home Sales and CarMax (KMX) Revenue
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