Mortgage rates surged to a 23-year high this week. The rate on the average 30-year fixed mortgage increased to 7.31% from 7.19% the week prior, according to Freddie Mac. That’s the highest rate since mid-December 2000, when it averaged 7.42%.
Expect dueling news watches this week. Garnering most of the pixels will be the countdown to a government shutdown if Congress doesn’t pass a stopgap continuing resolution to keep funding the federal government by September 30. Odds are good right now that the House of Representatives won’t meet the deadline and the many government departments will shut down next week. And on Friday, investors get the next release of the Federal Reserve’s favorite inflation series, the Personal Consumption Expenditures index.
At today’s meeting the Federal Reserve’s Open Market Committee left the central bank’s policy interest rate at 5.25% to 5.50%. In its Dot Plot forecast the Fed signaled one more interest rate hike for 2023. In its forecast the bank said that rates would end 2023 at 5.6%. That’s roughly 25 basis points higher than today. None of this was surprising. The markets were looking for the Fed to stand pat at this meeting. Odds of that according to the CME FedWatch Tool were above 98% heading into the meeting. The market was calling the possibility of one more interest rate incree in 2023 essentially a coin toss. But the Fed did surprise for 2024.
In this Special Report I’m going to start by sorting out the data that the market’s moves will likely depend on for the rest of 2023. That’s today’s post, Part 1 of this Special Report. Then I’ll try to handicap the likelihood that the data will zig or zag. And give you a sense of how far away from the current consensus the actual result might fall. And then finally, I’ll give you 10 moves for the rest of 2023 that are the most likely, in my opinion, to result in profits and that won’t wind up costing you big if the data winds up throwing investors a curve.
Watch what the Federal Reserve says on Wednesday not what it does at the interest-rate setting meeting of the Open Market Committee. Everybody, I mean everybody, expects that the Fed will hold its benchmark interest rate steady at the current range of 5.25% to 5.50%. The odds, calculated from prices in the Fed Funds Futures market by the CME FedWatch Tool, stand at 98% that the central bank will do nothing. But this meeting also includes an update of the Fed’s Dot Plot forecast for future interest rates, inflation, unemployment and GDP growth. And those numbers will give investors the best available clue on what the Fed will do at its November meeting and int 2024.
The theory, for today at least, is that the uptick in CPI inflation for August doesn’t change the basis calculus at the Federal Reserve.
CPI headline, all-items inflation rose at a 3.2% annual rate in July. That was up from the 3% annual rate in June and the first increase after 12 months of steady declines. But the uptick seems mostly an artifact of higher housing costs, an item that shows a longer-term downward trend in prices. The market read this morning is, therefore, that this is continued good news on inflation and that it cements the likelihood that the Fed will stand pat on interest rates at its September 20 meeting. The CME FedWatch tool put the odds of no increase from the Fed on September 20 at 90.5% today. That’s up from odds of 86% yesterday, August 9. But if the question of what the Fed will do in September is settled (in the market’s mind at least), the issue of what the Fed will do (or say) about the future direction of interest rates remains uncertain.
Today’s Trend of the Week: Corporate Profit Margins–The Other Inflation Problem. The market is currently unsure if the Fed will continue to raise rates in September and December. Complicating the Fed’s job of bringing inflation: The trend in corporate profits. Profit margins are projected at 11.1% for the second quarter, down from 11.5% in the first quarter and down from 12.2% in this quarter a year ago. The five year average is 11.4%. Six straight quarters of declining profit margins have companies looking for more ways to bring the margins back up. Any company that still has pricing power is likely to be raising prices. As an example, Spotify raised its U.S. subscription price to $10.99 a month from $9.99 a month- a reasonable, one-dollar increase that will defend the company’s profit margin. The Fed, of course, doesn’t want companies raise prices as the central bank tries to stem inflation by raising interest rates. However for the time being, companies are doing whatever they can to increase profit margins and that includes raising prices on things like toothpaste, if they can, much to the Fed’s chagrin.
Today’s Trend of the Week is Consumers are Skipping Essentials. The impact of high inflation has consumers moving down the price point ladder, and we’re now seeing people skip purchases for essentials. Unit purchases for essentials like toothpaste, laundry detergent and toilet paper are falling. It’s only inflation that keeps retail sales in dollars from dipping. From an investing perspective, this means there isn’t anywhere to hide. Target, which is a relatively inexpensive retailer, is reporting negative growth. Walmart and Costco are still positive, but that could change if this trend continues. In May, inflation adjusted household spending stalled and was essentially flat. Unit sales are down 3% to 4% in the 52 weeks through June 24. This is a sure sign that consumers are cutting back on spending. This all before consumer incomes take a hit with the resumption of college loan payments in October. My advice: be careful out there.
Yesterday, the Bureau of Labor Statistics reported that all-items inflation rose at just a 3% annual rate in June. That was a huge drop from the 4% annual rate reported in May. The inflation numbers immediately prompted Wall Street to, again, declare that the Federal Reserve’s cycle of interest rate increases would end “soon.” “Soon” is now defined as after the Fed’s July 26 meeting. Fed officials have been so adamant in recent days about the need for more interest rate increases that the odds of 25 basis point increase at the July 26 meeting barely budged after the June CPI report. Today the CME FedWatch Took, which calculates the odds of a Fed move by looking at prices in the Fed Funds Futures market (and is, thus, a measure of investor sentiment rather than speculation on Fed thinking) puts the odds of a July 26 25 basis point increase at 92.4%. That’s down only slightly from the 94.2% odds before the CPI inflation report. The big move has been in the odds for a second 25 basis point increase at the Fed’s September 20 meeting. Today, the odds are just 11.1%. That’s down from 13.2% odds of a 25 basis point move in September on July 12. And down big from 27.5% odds of another interest rate increase in September on July 6. And there’s the Fed’s problem.
Look for big news on inflation and earnings this week. But I think the news is baked into stock prices so I don’t expect much of a move on the news.
Today’s video is Investing in Inflation. I went shopping at Costco and Target on the Saturday before July 4 and didn’t buy anything at either store.But for two very different reasons. Costco was mobbed with lines longer than I’ve ever seen and Target was nearly empty, as were many of its shelves. While Target does sell some groceries, it’s not a destination for bargain-hungry food shoppers that Costco is. Headline inflation–or “all-item” inflation–is down, but core inflation, which includes food, is still at 5.3%. That’s enough price inflation to hurt and consumers are looking to focus on saving pennies and dollars at a store like Costco. A comparison chart of Target and Costco stocks shows a huge divergence in May between the two retailers, with Costco marching steadily up, and Target diving down. I don’t expect core inflation to come down dramatically any time soon, so investing in inflation is a good bet here. Check back tomorrow for a stock play on high core inflation.
