Fed to Begin Unwinding, Signals Another Hike

Charles Schwab: On the Market

Posted: 9/20/2017 4:15 PM ET

Fed to Begin Unwinding, Signals Another Hike

U.S. equities finished mixed, rebounding from a brief tumble that came after the Fed left rates unchanged, as expected, but signaled a December hike is likely to be in the cards. Treasury yields rose following the Fed decision, which included insight into the winding down of its behemoth balance sheet, while the U.S. dollar jumped and gold reversed to the downside. Meanwhile, crude oil prices rose following a mixed government oil inventory report and U.S. existing home sales unexpectedly dropped.

The Dow Jones Industrial Average (DJIA) increased 42 points (0.2%) to 22,413, the S&P 500 Index gained 2 points (0.1%) to 2,508, while the Nasdaq Composite declined 5 points (0.1%) to 6,456. In moderate volume, 837 million shares were traded on the NYSE and 2.0 billion shares changed hands on the Nasdaq. WTI crude oil rose $0.79 to $50.69 per barrel and wholesale gasoline was unchanged at $1.66 per gallon. Elsewhere, the Bloomberg gold spot price decreased $10.39 to $1,300.76 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—was 0.8% higher at 92.49.

FedEx Corp. (FDX $221) reported fiscal Q1 earnings-per-share (EPS) of $2.19, or $2.51 ex-items, versus the $3.09 FactSet estimate, as revenues rose 4.1% year-over-year (y/y) to $15.3 billion, below the projected $15.4 billion. The company cited the negative impacts of the cyberattack at its TNT Express unit and Hurricane Harvey. FDX lowered its full-year profit outlook. Shares overcame early pressure and finished higher as analysts appeared to be looking past the TNT cyberattack-induced miss, noting an unchanged long-term outlook and strong fundamentals.

Bed Bath & Beyond Inc. (BBBY $23) posted fiscal Q2 EPS of $0.67, or $0.78 ex-items, compared to the forecasted $0.95, with revenues declining 1.7% y/y to $2.9 billion, missing the expected $3.0 billion. Q2 same-store sales fell 2.6% y/y, versus the estimated 0.7% decline. BBBY lowered its full-year guidance, and shares tumbled.

General Mills Inc. (GIS $52) announced fiscal Q1 profits of $0.69 per share, or $0.71 ex-items, versus the estimated $0.76, as revenues decreased 3.5% y/y to $3.8 billion, roughly in line with forecasts. GIS noted that its U.S. yogurt segment sales were down double-digits and its cereal and snacks unit sales also declined. The company's gross margin fell solidly due to higher input costs, deleverage, and unfavorable trade expense phasing. GIS reiterated its full-year guidance. Shares fell.

Adobe Systems Inc. (ADBE $150) reported Q3 EPS of $0.84, or $1.10 ex-items, versus the estimated $1.01, as revenues grew 26.0% y/y to $1.8 billion, mostly matching expectations. However, shares were lower as the company's experience cloud bookings missed expectations for the quarter, leading to a warning that its Adobe Marketing Cloud segment will not achieve its bookings goal for the year.

Fed to begin balance sheet unwinding, existing home sales surprisingly drop

The Federal Open Market Committee (FOMC) concluded its two-day monetary policy meeting, agreeing to keep the target for its fed funds rate steady at a range of 1.00%-1.25%, a move that was widely expected. The FOMC also kept its near-term rate outlook intact, with 12 of 16 Committee members projecting at least one additional rate increase for 2017, but it lowered its longer-term outlook, indicating 11 of 16 Members forecasted three hikes in 2018. In its statement, the FOMC said that near-term risks to the economy are “roughly balanced,” that the labor market continues to be strong, and that the Committee "is monitoring inflation developments closely." In regards to the recent hurricanes, the Fed indicated that "disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term." In a separate statement, the Fed also provided details of its plan to begin to wind down its $4.5 trillion balance sheet. In a unanimous decision, the Fed will begin to taper its balance sheet by $10 billion per month—$6 billion from Treasuries and $4 billion from mortgage-backed securities—increasing by $10 billion per month every quarter for the first year.

As well, the Fed provided updated economic projections, showing a slight upward change to gross domestic product for this year, while lowering its forecasts for inflation and keeping its the unemployment rate expectations the same. In her press conference following the decision, Fed Chairwoman Janet Yellen said that she is heartened by the labor market improvement and expects the economy to expand at a moderate pace, but that the Committee is prepared to act if the economy begins to deteriorate. For more insightful analysis of the Fed’s decision, see Schwab's Chief Investment Strategist Liz Ann Sonders' article, The Fed's on the QT, on the Markets & Economy page at www.schwab.com, while you can also follow Liz Ann on Twitter: @lizannsonders.

Existing-home sales in August fell 1.7% month-over-month (m/m) to a 5.35 million annual rate—the lowest in a year—compared to the Bloomberg forecast of a 5.45 million pace, and versus July's unrevised 5.44 million rate. Sales of single-family homes dropped 2.1% m/m, but remained slightly above year ago levels, while purchases of multi-family structures rose 1.7%, but were lower y/y. The median existing-home price was up 5.6% y/y at $253,500. Unsold inventory came in at a 4.2-months pace at the current sales rate, down from the 4.5 months rate a year ago. Inventory of homes for sale declined 2.1% m/m, and are down 6.5% y/y, falling for 27 consecutive months. Sales jumped in the Northeast and rose in the Midwest, while sales fell in the South and West. Existing home sales are based on contract closings instead of signings and account for the majority of the housing sales market.

The National Association of Realtors (NAR) noted that sales in the South were hampered by Hurricane Harvey but Chief Economist Lawrence Yun said, "What's ailing the housing market and continues to weigh on overall sales is the inadequate levels of available inventory and the upward pressure it's putting on prices." Despite the supply headwinds facing existing home sales, housing demand remains solid, buoyed by the positive employment front, a key area supporting our view in the latest Schwab Market Perspective: A Cat and Mouse Fall, that the bull market will likely continue. Read more on the Markets & Economy page at www.schwab.com, as well as Schwab's Liz Ann Sonders' article, Trying to Reason with Hurricane Season: The Aftermath of "Harma", where she notes that a boost associated with the recovery/rebuilding efforts is likely. Follow Schwab  on Twitter: @schwabresearch.

The MBA Mortgage Application Index dropped 9.7% last week, giving back most of the previous week's 9.9% jump. The fall came as an 8.5% drop in the Refinance Index was met with a 10.8% tumble for the Purchase Index. The average 30-year mortgage rate ticked 1 basis point (bp) higher to 4.04%.

Treasuries finished mostly lower, as the yield on the 2-year note rose 3 bps to 1.44%, the yield on the 10-year note gained 2 bps to 2.27%, and the 30-year bond rate was flat at 2.82%.

Tomorrow's economic calendar will begin with weekly initial jobless claims, which are forecasted to have moved higher to a level of 302,000 from the prior week's 284,000, as well as the Philly Fed Manufacturing Index, with economists anticipating a reading of 17.1 for September following August's 18.9, and culminating with the Index of Leading Economic Indicators (LEI) for August, anticipated to match July's 0.3% m/m increase.

Europe and Asia mixed as markets eye Fed decision

European equity markets finished mixed, with financials seeing some pressure though energy issues gained ground. The markets traded cautiously ahead of today's monetary policy meeting by the Fed in the U.S., which comes on the heels of the European Central Bank signaling that it will begin to discuss dialing back its stimulus measures this fall and the Bank of England noting that a rate hike could be announced in the coming months. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, discusses the potential changes in global monetary policy in his latest article, How the Shift by Central Banks May Affect the Stock Market, noting that despite the coming shift by central banks towards trimming/tapering their balance sheets, we don't believe the bull market is at risk. Read more on the Markets & Economy page at www.schwab.com including Jeff's point that earnings, not easing, remain the key support for stock markets around the world. The euro was flat and the British pound advanced on the U.S. dollar, while bond yields in the region finished mixed. In economic news, U.K. retail sales grew much more than expected in August.

Stocks in Asia finished mixed as the markets treaded cautiously ahead of today's monetary policy meeting by the U.S. Federal Reserve, while looking to tomorrow's decision by the Bank of Japan. Mainland Chinese equities and those traded in Hong Kong gained modest ground, while markets in Australia and South Korea declined. Stocks in Japan slightly extended yesterday's jump, with the yen holding onto recent weakness and following the nation's trade report, which showed exports grew more than expected in August. Markets in India finished flat. Schwab's Jeffrey Kleintop, CFA, offers analysis of the global investing landscape in his articles, What are fund flows telling us about trends and risks in the global stock market?, and, An important benefit to global investors is back after 20 years, on the Markets & Economy page at www.schwab.com.

In addition to the Bank of Japan's monetary policy decision, the international economic calendar will offer the All-Industry Index from the island nation, industrial orders from Spain, and public sector net borrowing from the U.K.

Financial Review

Saying Nothing

Sinclair Noe — June 6, 2016

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DOW + 113 = 17,920
SPX + 10 = 2109
NAS + 26 = 4968
10 Y + .02 = 1.72%
OIL – .01 = 49.68
GOLD + 1.20 = 1245.70

The S&P 500 closed at a 7 month high and is now just 21 points from the record high back in May of last year.

Federal Reserve chair Janet Yellen delivered a speech today in Philadelphia. The event was the last insight into Fed thinking before a media blackout takes effect ahead of the June 14-15 monetary policy meeting. One week ago, the market betting was on a June or July interest rate hike from the Fed; then Friday, we saw the very, very weak non-farm payrolls report from the Labor Department. The economy added just 38,000 jobs in May, the smallest gain since September 2010. So, what did Yellen say about the Fed’s stance on rate hikes now?

Well, it depends on what you wanted to hear. Yellen said the jobs report was disappointing but she warned against attaching too much significance to it on its own. Yellen said. “Other timely indicators from the labor market have been more positive.” Amid the “countervailing forces,” she said, “I see good reasons to expect that the positive forces supporting employment growth and higher inflation will continue to outweigh the negative ones. As a result, I expect the economic expansion to continue, with the labor market improving further and GDP growing moderately.”

Yellen listing four main risks to the U.S. economy – slower demand and productivity, and inflation and overseas risks – before downplaying them all. Yellen told the World Affairs Council of Philadelphia: “If incoming data are consistent with labor market conditions strengthening and inflation making progress toward our 2 percent objective, as I expect, further gradual increases in the federal funds rate are likely to be appropriate.”

So, if you think Yellen should be dovish, what you heard is that the Fed might hike rates in September or December. If you are more hawkishly inclined, then you are probably looking at July or September, plus December. Right now, market pricing doesn’t give the Fed more than a 50% chance of raising rates until the December 14, 2016, meeting. A rate hike in June is priced at just a 2% chance; July is at just 27.5%.

And if you think Yellen was intentionally vague and is growing weary of all this guessing, and she might just flex some muscle and hike rates next week, just to end all the speculation, then this quote probably caught your attention: “Because monetary policy affects the economy with a lag, steps to withdraw this monetary accommodation ought to be initiated before the FOMC’s goals are fully reached.”

Stocks, the dollar and bond yields all moved lower in the immediate aftermath of the speech, then recovered as if nothing happened. Lurking in the bond market is a $1 trillion reason for the Federal Reserve to go slow on interest-rate increases. That’s how much bondholders stand to lose if Treasury yields rise unexpectedly by 1 percentage point, according to a Goldman Sachs Group estimate.

With only a few weeks to go until Britain holds its referendum, fresh polls have shown an increase in support among voters for the U.K. to leave the European Union, swinging toward a Brexit. Results from an online poll by ICM showed those wishing to leave the EU at 48%, and those wanting to remain in at 43%, with 9% undecided.

The International Monetary Fund says Brexit would either be pretty bad or very bad. The Organization for Economic Cooperation and Development warns that there would be dire consequences not just for Britain, but for the rest of the world. The Bank of England says output would go down and inflation would go up. Of course, the IMF, the OECD, and the BOE have the prognostication skills of a brick.

Treasury Secretary Jacob Lew and Secretary of State John Kerry are in Beijing for the eighth round of the U.S.-China Strategic and Economic Dialogue as tensions simmer over Beijing’s land-reclamation in the South China Sea. Chinese authorities are likely to complain about recent anti-dumping steel tariffs and ask that the U.S. recognize its country as a market economy, while American officials want China to adopt further financial liberalization, address industrial overcapacity and refrain from more yuan devaluations. Dinner will be served, nothing will change, and everybody will go home.

Saudi Arabia plans to more than triple the government’s non-oil revenues and clamp down on public sector salaries over the next five years; ministers announced reforms designed to reduce the economy’s dependence on oil. The plan is part of a wider, long-term reform drive known as Vision 2030, which was announced by Deputy Crown Prince Mohammed bin Salman in April. He aims to overhaul many aspects of Saudi Arabia’s economy and society as the kingdom prepares for a future of shrunken oil revenues and a rising population.

Today the government announced they will cut public wages and borrow billions of dollars. Last week Saudi Arabia’s sovereign wealth fund announced a $3.5 billion investment in Uber.  It’s one of the biggest venture capital investments in history and brings Uber’s overall fundraising haul to $11 billion. Those investments might allow Uber to expand its share of the global ride-hailing market and make big profits for its investors.

But money spent on money-losing price competition isn’t investment. Price wars do nothing to increase the world’s productive capacity. So the fact that so much money is being invested in Uber, and in other companies deliberately losing millions in an effort to gain market share, could be an ominous sign. It suggests that it’s getting harder and harder to spend money in ways that boost long-term economic growth.

More than 25 European and Asian-owned supertankers are now shipping Iranian crude, allowing the Islamic Republic to ramp up exports much faster than expected following the lifting of sanctions in January. Tehran was struggling as recently as April to find partners to ship its oil, but after an agreement on a temporary insurance fix, more than a third of Iran’s crude shipments are now being handled by foreign vessels. Iran shipped 2.3 million b/d in April 2016, the highest level since 2012. These figures are 15 percent higher than the International Energy Agency forecast.

The Supreme Court today declined to hear GlaxoSmithKline’s bid to throw out lawsuits by union health and welfare funds that said the company’s misrepresentation of heart-related risks of its diabetes medication Avandia caused them to pay too much for the drug for insured patients.

The court left in place a 2015 ruling by the 3rd Circuit Court of Appeals against GlaxoSmithKline that allowed the class action lawsuits to proceed. The suits were filed by three labor union funds that provide medical coverage, including the cost of prescription medications, to union members and their families.

The lawsuits filed between 2007 and 2010 allege that GSK violated the Racketeer Influenced and Corrupt Organizations Act, or RICO, by fraudulently concealing the risk of cardiovascular injury. GSK has since settled claims by 46 U.S. states and thousands of users, without admitting any wrongdoing.

The Supreme Court also rejected Google’s bid to throw out a class action lawsuit involving claims that the company deceived California advertisers about the placement of Internet ads through its Adwords service. The court’s decision not to hear the case leaves in place a September 2015 ruling by the San Francisco-based 9th Circuit Court of Appeals that the litigation could move forward as a class action representing advertisers who used the service between 2004 and 2008.

A federal district court judge in 2012 ruled that the case could not move forward as a class action in part because each advertiser would receive different damages. Each advertiser would have paid a different sum for the ads in question, the judge said. The appeals court reversed the district court, prompting Google to ask the Supreme Court to intervene, which they did not.

The Supremes also rejected Ecuador’s challenge to a $96 million international arbitration award in favor of energy company Chevron. The dispute stems from a 1973 deal that called for Texaco Petroleum, later acquired by Chevron, to develop oil fields in exchange for selling oil to Ecuador’s government at below-market rates.

Texaco filed several lawsuits in the 1990s accusing Ecuador of violating the contract. The case is not part of a separate legal battle brought by a group of Ecuadorean villagers who claim Texaco caused billions of dollars in pollution damage when it began exploring oil deposits in the 1960s.

Impossible Foods aims to disrupt the food industry by developing meat products from plant-based ingredients. Launched by a top biochemist from Stanford, the startup says it’s on the verge of offering an alternative that looks, smells, and even sizzles like regular ground beef.

We’ve been told over and over again by online security experts not to use the same passwords for multiple sites. And apparently Facebook’s Mark Zuckerberg is just as lax as the rest of us in actually following that advice. Zuckerberg’s accounts at Twitter, Pinterest and Instagram were hacked this weekend, apparently because he had re-used his LinkedIn password — which was one of more than 100 million passwords stolen in 2012 and dumped online last month.

Just in case you were wondering Zuckerberg’s password was “dadada”. A 2013 study found 55% of all Internet users use the same passwords for most, if not all, sites they visit. So if one account gets breached, all are potentially exposed.