Stocks rallied Friday and this week, as fears calmed following Fed Chair Jerome Powell’s testimony to Congress earlier in the shortened week, and Fed Chair James Bullard's comments that recession fears are overblown on Friday morning.
The switch in sentiment means traders are now pricing out Fed rate hikes after December and the possibility of rate cuts in 2023.
Powell’s Testimony
Fed Chair Jerome Powell testified in the semiannual Monetary Policy Report to Congress this week.
The comments were mostly expected. The Fed Chair acknowledged that a “soft-landing” - when price pressures ease while rates rise without causing a recession - would be “very challenging”. Powell noted that policymakers must remain on standby, ready to react to an ever-evolving climate in order to avoid allowing high inflation to become entrenched in the economy and that his commitment to curbing inflation is “unconditional” as he underscored the need to restore price stability.
This has St. Louis Federal Reserve President James Bullard in favor of more front-loaded rate hikes. Bullard sees a slowing in growth but thinks it's too early to talk about a recession as the Fed official sees only “moderate” slowing. Bullard attributed this opinion to built-up wealth as $3.5 trillion in unspent Covid aid, which represents some 10% of GDP, that can help buoy spending.
Gas Tax Holiday
Oil prices fell this week as the Biden Administration moved to recommend a tax holiday on gasoline and diesel fuel. The move is aimed at lowering prices for consumers by removing the added tax cost, not by actually changing the supply and demand dynamics that have pushed prices upward.
While this may provide short-term relief to consumers, it can have the opposite effect over the long term. A study by the Wharton School at the University of Pennsylvania found that, following the conclusion of the tax holiday, prices can jump higher than they would have been had the holiday not been implemented.
Savings were “mostly passed on to consumers at some point during the tax holiday in the form of lower gas prices” but also weren’t “sustained during the entire holiday”.
Federal Tax on gas gets paid for by the refiner when it gets shipped out, while the state tax gets paid by distributors or refiners. How much that cost gets passed down to consumers depends on how stable the supply is during those months.
If driving habits stay the same, then savings to consumers are maximized. If people drive more because now they can afford to drive more, then the price of gas will rise and erase some-to-all of the tax savings. Further, the new driving habits would mean that, when the tax holiday concludes, the end price would be as high or higher for consumers.
Home Sales
This week had a housing market update, first via the Existing Home Sales on Tuesday and then the New Home Sales report on Friday.
Existing sales narrowly topped estimates with an annualized rate of 5.41 million homes sold, while new homes solder at a much faster rate than expected at a yearly rate of 696,000 homes.
The reports coincided with a contraction in mortgage rates during May. This could point toward an unsustainable rush to purchase homes as rates have risen since and both Existing and New Home Sales took a hit from March to April as rates rose.
All told, markets rallied this week. The S&P 500 rose 6.45%. The Nasdaq added 7.49%, while the Russell 2000 and Dow gained with 5.39% and 6.01%, respectively.
