Published October 7, 2022
The market is obsessed with the impact of sharply rising interest rates. The brief below from Delta outlines some of the impacts of this sharp change in Fed policy and what investors are looking for to turn the markets around.
“The Federal Reserve is now projecting a terminal Fed Funds rate of about 4.6%. This is up from about 3.8% over the past month. On August 1, the 10-year US treasury was about 2.6%. Today, it is approaching 4.0% – a dramatic increase in a short time.
The greater than 40% increase in the 10-year rate places a significant braking force on the economy and stock market. One example is the housing market.
30-year mortgage rates are now greater than 6% for the first time since November 2008 and 137% greater than the low (2.65%) set in January 2021.
Higher rates are putting pressure on housing prices which are rolling over.
The total monthly payment on a median single-family home has jumped 50% from $1,660 in January 2021 to $2,500 today (includes mortgage payment, property tax and insurance).
The full impact of rate increases on the overall economy will not be felt for months. Given the speed at which rates have risen, it is somewhat surprising how well stocks have held up. The low in the S&P 500 index in 2022 year-to-date was in mid-June at 3,637 with the 10-year treasury at 3.4%. Today, the S&P 500 remains above its low even with interest rates a good deal higher.
The stock market is being pulled by opposing forces. On the downside, the current interest rate environment is substantially worse, likely leading to a more significant economic slowdown and increased pressure on P/E multiples. On the upside, investors are anticipating the end of rate hikes and an eventual reduction in rates. At the moment, the market projects a rate hike peak in the Spring of 2023. The stock market tends to look out 6 to 9 months. Thus, the market is trying to price in where the economy and rates will be next Spring when interest rates are projected to peak. But will rates fall back from there? Or remain flat at that higher level? How much will earnings projections fall next year?
Unfortunately, the stock market will remain volatile until there is more clarity on these issues, or at least a positive narrative around which investors can rally.
Another very volatile week for investors began with a serious bounce. The prior Friday’s slide had left stocks below their June lows, a bearish signal. But bargain-hunting investors bought the oversold market Monday with a dramatic +2.6% rally to kick off the usually strong 4th quarter of the year. Oil prices rose +4% on news of an OPEC oil production cut while Tesla fell on a miss in car deliveries. Fears of a blowup in European bank Credit Suisse proved unfounded, for now, while the prior week’s upset over the UK’s policy moves looked to have settled down. Tuesday brought a second day of hefty gains with a +3.1% leap. Investors looked favorably on a drop in job openings and increase in layoffs combined with a less-than-expected interest rate rise in Australia. The strong two-day rally felt like the beginning of a strong fourth quarter recovery. Economic reports released Wednesday showed a still-strong economy dashing investor hopes for a slowdown. The news sent stocks down -2% at the outset of Wednesday’s trading. A slowdown in the economy and easing in the tight labor market would give the Fed room to back down from their ferocious attack on inflation. But the Monday/Tuesday enthusiasm eventually brought in buyers to push stocks back to breakeven by the close. Thursday saw the bears step forward again to pull markets down -1% as investors looked cautiously toward the release of monthly jobs numbers Friday morning. Those numbers disappointed investors by confirming the strength of labor markets. Stocks got blitzed on the report falling -2.8% with the Nasdaq 100 (QQQ) down almost -4%. Bond yields ticked higher with the 10-year rate back near 4%.
A weekly win for the bulls, but hardly one worth celebrating as indexes gave up big gains. The S&P 500, up over +5% earlier in the week, closed with a +1.57% weekly move. The Nasdaq 100 (QQQ) ended the week +0.69%. Smallcaps fared better with a +2.24% gain.
Warm wishes and until next week.