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Investors Appear Hesitant As They Digest New Interest Rate Narrative

Published 02/11/2022, 10:25 AM
Updated 03/09/2019, 08:30 AM

Thursday’s hotter-than-expected Consumer Price Index and comments by St. Louis Federal Reserve President James Bullard sent both stock and bond markets downward on a day where there appeared to be no safe harbors. However, it’s a new day, and investors appear to be open to a new narrative.

CPI Deflates Stocks

On Thursday, the bulls were holding their own after a hotter-than-expected CPI reported inflation grew 0.6% month over month, which was above the expected 0.5%. It also grew at 7.5% year over year, which was also above the forecasted 7.3%. Economists were hoping for some easing in inflation with the holidays well behind us, but these were the hottest numbers since February 1982.

The S&P 500 fell on the market open in reaction to the news, but rallied back to Wednesday’s highs. However, after the market had come off its highs, St. Louis Federal Reserve President James Bullard told Bloomberg News in an interview just a couple hours into the trading day that he wanted to see the federal funds rate at 1% by July 1. This caused investors to start selling stocks, and the SPX ended the day 1.81% lower.

The sell-off was broad with decliners outpacing advancers by about 3-to-1. The Nasdaq Composite dropped 2.1%. And the Dow Jones Industrial Average fell 1.47%. Small-cap stocks were able to hold strong most of the day, but the Russell 2000 eventually succumbed to the selling, causing the index to close 1.55% lower.

Busting Bonds

The day’s biggest action was probably in the bond market. The CPI report drove the 2-year Treasury yield up nearly 26 basis points to 1.609%. You’ll remember that the 2-year yield is the one that tries to anticipate the federal funds rate, which means the bond market is expecting the Federal Reserve to aggressively go after inflation. The federal funds rate is still at zero as the Fed is nearer to wrapping up its stimulus bond-buying program next month.

The rising 2-year yield also sent ripples throughout the yield curve. The 10-year Treasury yield shot up to 2.1% before pulling back to close at 2.031%. Despite the rising 10-year yield, the yield curve as measured by the 2s10s ratio flattened, dropping below 0.5. At this point, there’s about half a point difference between the 2-year and the 10-year yields.

The 10-year yield tends to be correlated with mortgage rates. According to Mortgage News Daily, the 30-year mortgage daily index moved back up above 4% for the first time since May 2019. The S&P Homebuilders Select Industry fell 3.51% on Thursday under the fear that rising rates could greatly slow down the housing market. With lumber futures trading around $1,200 per board foot and rising rates, the hot housing market may finally see some cooling.

A New Day

This morning, the 2-year Treasury Yield has pulled back to 1.557% as investors appear to be reconsidering the news and its effects. With the move in the 2-year yield on Thursday, the CME FedWatch Tool had spiked up to a 93.5% probability that the Fed will raise the federal funds rate a half a point in March, but it has since moved lower to 77.3%. One reason for this may be because other Fed members have commented on raising rates too. San Francisco Fed President Mary C. Daly said her preference isn’t a half-point hike, and Richmond Fed President Tom Barkin said he was “open to it conceptually.” Currently, the market appears be pricing in five rate hikes in 2022, but Goldman Sachs (NYSE:GS) changed its forecast overnight to seven hikes.

The Cboe Market Volatility Index (VIX) had moved nearly 5.5% this morning, but it has pulled back to less 1%. At the same time, the S&P 500 and Nasdaq futures had fallen overnight but are now flirting with positive territory. Additionally, investors have plenty of earnings announcements to sift through, although there aren’t many stocks that have the ability to move the markets. Yet, there are plenty of interest.

Before the open, Dominion Energy (NYSE:D) had a surprising miss on earnings and revenue. With energy being the hot sector, Dominion appears to be getting a bit of a pass because it was down just 0.61% in premarket trading. Additionally, oil prices were back over $91 per barrel before the opening bell.

Sports apparel company Under Armour (NYSE:UA) posted better than expected earnings but is down 1.5% in premarket trading. Despite beating estimates, UA reported that higher freight costs hurt their margins. Additionally, the company is seeing supply chain issues which has caused them to reduce their spring and summer order book.

After Thursday’s close, Expedia (NASDAQ:EXPE) rallied 5.83% in response to reporting better-than-expected earnings despite missing on revenues. EXPE said it was expecting a “brighter year ahead” and that the Omicron variant wasn’t as big as a disruption that many had predicted.

Genomics sequencer Illumina (NASDAQ:ILMN) reported it soundly beat earnings estimates thanks to a 26% increase in revenues. The company was only up 0.18% in after-hours trading.

One company that reminded me of the power of social media and how it relates to earnings was Affirm (NASDAQ:AFRM). Affirm actually rallied 12% after some of its key earnings metrics were accidentally leaked on Twitter (NYSE:TWTR) before its schedule announcement after the market close. The company reported a 218% increase in the number of transactions that helped revenue increase 77% year over year. The company went ahead and released the rest of its report, which actually led to a reversal in the stock. AFRM ended the day 21.42% lower because its earnings outlook was weaker than expected, and the company sidestepped questions about its future with Peloton (NASDAQ:PTON).

S&P Homebuilder Select Industry Index Chart.

CHART OF THE DAY: TRIANGULATING HOMEBUILDERS. The S&P Homebuilder Select Industry Index (SPSIHO—candlesticks) has created a triangle pattern.Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Technicals On Triangles: My technical analyst friends tell me that triangle patterns tend to be continuation patterns, which means if the stock was rallying into the pattern, the breakout in the pattern will be bullish. If the pattern occurred after a down trend, the breakout will be down, too. However, this isn’t always the case, so technical traders can just focus on the breakout and not worry about the previous trend. Perhaps Friday’s Michigan Consumer Sentiment report will be a driving force in the breakout.

Show Me The Money: Whenever investors become large sellers in a particular asset class, it makes sense to try and determine where they’re moving their money. General wisdom and the pattern most often seen is that when bonds fall, stock prices will rise. Obviously, that was not what happened today. But it’s rare to have stocks and bonds both fall or rise over extended periods of time. So, it makes sense for investors to pay attention to which asset classes move over the next few days because those could be signals as to where investors are buying, and which asset classes are rotating into favor.

Disclaimer: TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

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