After raising benchmark interest rates in December by 0.25% for the first time in nearly a decade, it seemed that Fed policymakers slipped into one-and-done mode – with no more rate hikes or even the hint of one – over the past five months.
Then yesterday, the Fed caught markets by surprise. The minutes released from its last meeting in April showed that Fed members expect another interest rate increase is warranted as early as mid-June if economic data continues to improve.
Talk about a wicked curveball, just as investors had come to believe in a dovish Fed.
|Stocks, already under pressure in recent weeks, plunged on the news.|
Just a month ago, Fed funds futures markets were pricing a ZERO percent chance of a rate hike in June. And the odds of a hike by December weren’t much better than 50/50. But that was before yesterday’s minutes.
It was no surprise that stocks, already under pressure in recent weeks, plunged on the news. In fact, the Dow dropped nearly 300 points from 2pm yesterday to this morning’s low. Commodities also did an abrupt about face, with gold and oil plunging, as the dollar surged higher.
Markets hate uncertainty, and the Fed just stirred fresh doubts about the direction of interest rates
In fact, even before the Fed news, there was already a growing list of market trends to worry about.
#1: Sour Seasonality: It’s the merry month of May, but for stocks, it’s traditionally time to sell and go away.
Historically, May through October is the worst 6-month period of the year for stocks, according to S&P 500 data going back to 1928.
According to research by Merrill Lynch, the S&P 500 is up only 63.6% of the time during this period, while stocks gain 70.5% of the time from November to April. But it gets even worse.
Whenever stocks are unusually weak during the seasonally strong months (Nov. – Apr.), they perform even worse during the traditionally weaker summer and fall seasons.
The S&P 500 just declined 0.7% from November 2015 to the end of last month!
In the past, when stocks have declined during this seasonally strong period, the S&P 500 has suffered an average correction of 12% during the subsequent May-Oct. timeframe!
#2: Rising Credit Stress: Another big worry weighing on the minds of investors is the fragile state of credit markets, which could easily go from bad to worse in a higher interest rate environment.
Remember, high-yield markets got crushed earlier this year with junk bond spreads relative to Treasuries blowing out to the highest level since the 2008 financial crisis.
Granted, credit conditions have improved over the past month, but high-yield distress remains at levels well above those seen at prior market peaks.
If the Fed follows through with more interest rate hikes this year than expected, credit market conditions could quickly deteriorate once again, and it won’t just be the energy sector under stress the next time around. Stay tuned!
Rare retail good news: This morning, retail giant Wal-Mart (WMT) gapped up nearly 8% at the open after reporting profits of $0.98 per share, well ahead of street estimates that called for $0.88. It was WMT’s biggest earnings beat since 2001, and stands in sharp contrast to disappointing results from Target (TGT) and Macy’s (M) among others. Consumers are still shopping somewhere, even if only at rock-bottom prices.
Key data dates ahead of next Fed meeting: The Fed is on record saying a rate hike could come as early as its next policy meeting June 14-15, IF economic data continues to improve. So here are a few upcoming big data release dates to watch:
May 27: Watch for revisions to first quarter U.S. GDP. The initial read was a pitiful 0.5% growth during the first three months of 2016, but economists will be watching for a potential upward revision.
June 3: The May jobs report will tell the Fed how U.S. labor markets are doing. April was disappointing with only 160,000 payroll gains, well below the 224,000 average over the past 12-months.
June 14: Retail sales have been on an upswing and the May retail sales report will be a widely watched indicator of how well U.S. consumers are spending. This data has added significance since it’s reported on the morning the next Fed policy meeting begins. Stay tuned.
Fed-induced market swoon: As reported above, the S&P 500 Index slid to a seven-week low, breaking below the key 2,040 support level, and commodities got crunched too, after odds of the next Fed interest rate hike increased sharply overnight. Perhaps more telling, copper, crude oil and gold all plunged as the dollar strengthened. Metals and oil are among the best performing asset classes so far in 2016. Ditto for energy and mining shares. Is now the time for a reversal of fortune?
I want to hear what you think. Are we about to witness trend reversals in several key markets? What’s your outlook for stocks, gold and the dollar: higher or lower over the next three months?
Join the discussion below by sending me your comments!