Tightrope Walking: Fed Meeting Nears As Weak Data, Brexit Vote Raise Concerns

by: TD Ameritrade

Summary

Fed Chair Janet Yellen pretty much quashed any remaining ideas about a June rate hike in her speech last Monday.

The July meeting would seem to be the next best chance for a hike if the Fed is indeed going to try to raise rates twice this year.

Consumers felt a bit less optimistic in early June, but not by much compared with May, the University of Michigan reported in its preliminary consumer sentiment reading Friday.

This coming week could be like going to a movie when you already know the ending. The Fed is meeting, but almost no one expects it to raise rates.

That doesn't necessarily mean a dull week, however. There are key data coming in the form of May retail sales, the Producer Price Index (PPI) and the Consumer Price Index (NYSEARCA:CPI). And markets could be volatile ahead of the June 23 British Brexit referendum on whether to stay in or leave the European Union.

Fed Chair Janet Yellen pretty much quashed any remaining ideas about a June rate hike in her speech last Monday, noting that the May jobs report was "concerning," and not making reference to what she had previously said about raising interest rates "in the coming months." As of midday Friday, the probability of a June rate rise stood at 2%, according to Chicago Mercantile Exchange (CME) futures. The July probability was 23%.

The Fed meets Tuesday and Wednesday, with an announcement set for 2 p.m. ET Wednesday. Even if the Fed doesn't change rates, investors typically watch closely to see what Yellen says in the press conference that follows. Will Yellen give any hints about the future timing of rate hikes? What's her assessment of the economy?

Yellen is arguably walking a bit of a tight rope. The Fed has hinted at two rate hikes this year, but it's nearly mid-June and there hasn't been one, leading some analysts to suggest the Fed is falling behind the curve. Yet at the same time, Yellen has said the Fed would let data be its guide, and between the weak jobs report and the approaching Brexit vote, there's a lot of uncertainty.

The July meeting would seem to be the next best chance for a hike if the Fed is indeed going to try to raise rates twice this year. There's no press conference scheduled for after the July meeting, but if the Fed gets a good number from July payrolls and British voters decide to stay in the E.U., Fed officials have hinted they could raise rates without a press conference. That's a long way off, however, with the July meeting scheduled for July 26-27.

Arguably, the most important near-term data is Tuesday morning's retail sales, in part because the previous retail sales report, which showed a 1.3% rise for April, put a spark into the stock market. Investors are likely to watch Tuesday's data closely, because consumer spending represents two-thirds of the economy. The weak May jobs report raised concern about consumer health, and those concerns might be reinforced if retail sales come in weak.

On the other hand, stronger retail sales could put new strength into the U.S. dollar, which was rising against the euro as of midday Friday, in part due to a flight to quality that was manifesting itself across multiple markets. A stronger dollar often leads to lower commodity prices, including the price of oil, and U.S. crude oil had fallen below $50 by midday Friday. The question for this coming week is whether oil can maintain the $50 level, which some analysts believe is a price that might spur more U.S. oil drilling.

Another marker to watch this coming week is the Chicago Board Options Exchange (CBOE) VIX. The VIX rose to around 16 by midday Friday, from below 13 earlier this month, and is now above the long-term average. VIX is a widely-watched measure of market fears, and falling bond yields across Europe, Japan, and the U.S. helped send VIX much higher late in the week. It's possible VIX could remain elevated in the near future as investors brace themselves for the Fed meeting and Brexit vote. An elevated VIX is often associated with weaker stock markets.

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Figure 1: Still Pivoting Around 2100: The S&P 500 (SPX), plotted here through midday Friday on the TD Ameritrade thinkorswim® platform, continues to pivot around the 2100 mark like a moth around a light bulb. Last week's rise above that level was quickly followed by a drop below it, and by midday Friday it was being challenged again. Source: Standard & Poor's. For illustrative purposes only. Past performance does not guarantee future results.

Could Sluggish Market Be Bullish Sign? By midday Friday, it appeared possible that the S&P 500 Index (SPX) might break a long streak of days in which it's moved little to the upside or downside. The index hadn't had a more than 20-point separation between daily highs and lows since May 24. That's a marked change from early this year, when daily ranges of 40 or even 50 points occurred. So far, 2016 has been a tale of two chapters for the so-called "Daily rate of change," or DRC, of the SPX. The DRC averaged more than 1% from Jan. 1 through Feb. 11, but has averaged just 0.57% since, noted Argus Research, in a recent report. For June, the rate has been below 0.3%. History shows that lower DRC often equates with markets grinding higher, and the current low level suggests further upside for stocks, Argus Research said.

Consumer Optimism Down, But Not By Much: Consumers felt a bit less optimistic in early June, but not by much compared with May, the University of Michigan reported in its preliminary consumer sentiment reading Friday. Sentiment fell to 94.3 in June, from 94.7 in May, a drop that was less than consensus had expected. On the plus side, "Consumers rated their current financial situation at the best levels since the 2007 cyclical peak largely due to wage gains," said Richard Curtin, the survey's chief economist, in a press release. "Prospects for gains in inflation-adjusted incomes in the year ahead were also the most favorable since the 2007 peak, enabled by record low inflation expectations." On the negative side of the ledger, however, consumers do not think the economy is as strong as it was last year, nor do they anticipate the economy will enjoy the same financial health in the year ahead as they anticipated a year ago, Curtin said. This coming Tuesday's retail sales report could give the market an additional read on consumer sentiment.

Lower Bond Yields Seen Helping Certain Stocks: Though stocks took a bit of a hit early Friday due to sinking bond yields in the U.S. and overseas, there's one particular type of stock that might ultimately have a chance to gain if bond yields stay low. The current weakness in the U.S. 10-year Treasury yield, which was trading at around 1.65% as of midday Friday, could help make dividend yielding stocks more attractive, simply because investors may find themselves able to get better yields from dividend-paying stocks than from government bonds. Two well-known dividend stocks, AT&T (NYSE:T) and Verizon (NYSE:VZ), both rose more than 1% by midday Friday. Traditionally, U.S. Treasuries have been among the safest investments, and safety isn't something stocks typically promise. Even so, it will be interesting to see if investors begin to shift focus into higher-yielding stocks if the bond market keeps soaring. And another factor to watch: Lower bond yields can hurt financial stocks, and the financial sector was down nearly 1% as of midday Friday.

Good Trading,

Kevin

Inclusion of specific security names in this commentary does not constitute a recommendation from TD Ameritrade to buy, sell, or hold. TD Ameritrade® commentary for educational purposes only. Member SIPC.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.