The Fed May Step on the Gas Again

HIGHLIGHTS:

• A slew of economic data, including a noteworthy rise in retail sales, may be pressuring Fed officials to do more to fight inflation.
• US stocks flashed red in recent trading sessions, led lower by technology shares, while bond yields jumped higher, with the 10-year Treasury reaching 4.0 percent.
• The fourth-quarter earnings season is likely to come to a lackluster end with a marginal decline, but company guidance is reflecting growing negativity.
• Investors are betting the Fed will add on one or two more hikes, potentially reaching a rate of 5.25 percent by the middle of 2023.

A fickleness has returned to the markets. Investors are reassessing whether the Federal Reserve will resume a more aggressive path for rates after economic data remained stronger than expected. Last week, retail sales rose by the most in almost two years—meaning robust consumer spending could keep prices elevated—and jumped 3 percent in January. A slew of other releases signaled that the US economy has retained surprising momentum. However, that data comes on top of higher-than-expected results for consumer and producer prices, which doesn’t bode well for the Fed’s fight against inflation. As worries grew, US stocks declined by 3.6 percent over the last three trading days, led lower by technology, energy, and consumer discretionary shares. Unfortunately, earnings results aren’t really helping either.

The fourth-quarter earnings season is coming to a close, with 438 of the 500 S&P companies having reported. While the scorecard isn’t great, it also isn’t terrible. So far, companies have beat earnings forecasts by a little less than 2 percent—notably below the 5-year average of 8.6 percent. As such, earnings have declined by 1.1 percent, which will likely mark the first decline since mid-2020. Investors are dealing with marginal quarterly earnings numbers, but the real story comes from company guidance. For the first quarter of this year, 65 companies have issued negative earnings guidance. Only 20 have issued positive guidance, reflecting growing worries and declining forward-looking sentiment.

Bond markets have also seen some turbulence this year. After yields churned lower in January, that trend reversed sharply this month, with the benchmark 10-year Treasury yield climbing from 3.4 percent to yesterday’s high of nearly 4.0 percent. Similarly to stocks, the unease in bond markets stems from the increasing likelihood that Fed officials will need to resume their aggressive attack on inflation via higher rates. Fed funds futures data now show investors are betting the Fed will add another 25 basis point hike, or more, to its schedule. That could mean officials are mulling a key overnight rate of around 5.25 percent, or higher, by the middle of this year.

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