Stocks Rally After Fed Minutes
It’s surprising to hear that the Fed Minutes were dovish given the positive economic data. Rather than the Fed reacting to the data, it appears the Minutes showed a wholesale change in monetary policy. The new term which was used nine times was 'symmetric'. The theory is that inflation was below the target for so many years, it makes sense to allow it to get slightly above the target without slamming on the breaks by raising rates quickly. The Fed is already unwinding the balance sheet quickly. I think there’s no reason to raise rates quickly in this environment as inflation is still below the Fed’s goal. Growth has been stymied for so long; it doesn’t make sense to try to stop this recovery after decent growth finally is attained. The Fed is contextualizing this recovery as weak and is willing to let inflation run slightly hot to allow the economy to finally produce accelerated wage growth.
Some participants claim the Fed’s monetary policy is neutral which would imply the rate hikes are done. That’s not a serious opinion in my view as the Fed will be raising rates at least two more times this year and multiple times next year if the economy stays on a similar path. The fact that the debate over whether the Fed is getting close to the end of this rate hike cycle is occurring is an early warning sign that the Fed is getting close to the end. The Fed might be just one year away from the end of the cycle, so it makes sense to start warning the market by the end of this year.
One interesting possibility is if the economy doesn’t go into a recession in 2020 because the Fed stopped hiking rates. Then inflation would start to become a problem. The Fed would need to hike rates quickly, which would plummet the economy into a recession. I’m not saying that will happen. Instead, I’m reviewing an example of how the situation can go wrong. When you hear Fed policy, it usually sounds good on paper, but doesn’t work out in real life. The Fed’s plans have worked out ever since this expansion started besides the stretches of disappointing GDP growth and wage growth. That doesn’t mean the plans will continue to work out as recessions are tricky to plan for.
Market Reaction To Dovish Fed
Let’s review the market’s reaction to the Fed Minutes. I already mentioned that the stock market went from down slightly, to up 0.32%. The chance of 4 rate hikes in 2018 fell from 43.9% to 35.3%. The chance of just one more hike increased from 7.8% to 15.3%. The Fed is most definitely going to raise rates at the June 13th meeting, so that would mean no hikes afterwards.
It’s weird to see that the dollar index was up on a day the Fed was dovish. However, the dollar was up on the day already and paired its gains slightly after the Minutes were released. The DXY was up 0.61%. It’s at the highest point since November 13th, 2017. Treasuries rallied sharply on the news and the curve flattened. The 10 year bond yield fell about 6 basis points as it is now slightly below the 3% level. The 2 year yield fell about 4 basis points as it looks like the Fed will hike rates slower. The difference between the two yields is now 47 basis points.
Target Reports Weak Results
The stock market was down slightly on Wednesday morning as Target’s poor earnings results hurt market sentiment. The market rebounded to close positive after the Fed’s Minutes. The S&P 500 was up 0.32% and the Nasdaq was up 0.64%. I think it’s relevant to look into Target’s numbers because I’m focused on the consumer; I’m looking for a rebound in Q2. Target stock was down 5.7% as the firm missed EPS estimates by 7 cents, reporting $1.32. That’s a big miss for such a large company. The revenues also missed estimates as they were $16.56 billion which was below the estimates for $16.58 billion.
The good news is revenues were up 3.5% year over year. The bad news is operating income was down 9.9% because of price cuts and investments. It’s tough to come to a negative conclusion about the consumer from these results even though they missed estimates because traffic was up 3.7% which was the best performance is over 10 years. Also, the guidance for full year earnings of $5.15 to $5.45 and single digit comparable sales growth were reaffirmed. It doesn’t make sense to have a negative takeaway on the macro front just because Target is reinvesting so much back into its business. The firm plans to reinvest $7 billion through 2020. It completed 56 remodels in the quarter. This could be good news for workers and customers and bad news for the bottom line; that’s good for the overall economy.
Weakness in sales was caused by a delay of purchases of summer products like grills and patio furniture because the weather was cold. I think that’s a reasonable excuse in terms of looking at the strength of the consumer. However, if I was an investor in the firm, I wouldn’t be satisfied. The big transition the firm is making is quicker delivery as it rolled out same day delivery to more than 700 stores in the quarter.
I never reviewed Wal-Mart’s results from last week, so I quickly mention them. The firm did better than Target in terms of beating estimates as EPS of $1.14 beat by 2 cents and revenues of $122.69 billion beat forecasts for $120.51 billion. Same store sales growth of 2.1% beat by one tenth. The online business, which disappointed investors last quarter, grew 33%. Since the quarter, the stock is down 3.6%. These big box brick and mortar stores are trying to transition to online sales, but investors are punishing them while buying Amazon which is less than 1% off its all-time high. Amazon stock is up 8.3% in the past month.
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