Stocks Finish Higher Monday Ahead of Fed Rate Decision, Earnings Reports

Stocks finished higher Monday during a choppy day as traders look ahead to the Federal Reserve’s rate decision Wednesday, as well as a slew of rate decisions by central bankers around the world.

Covid vaccine makers plunged Monday after President Biden said that the pandemic is over in an interview on “60 Minutes”. Moderna (MRNA), Novavax (NVAX), and BioNTech (BNTX) all closed down by more than 7%.

Decisions, Decisions

The Federal Reserve and central bankers around the world are expected to continue raising rates to fight persistent inflation.

Economists and futures traders are expecting a 75-basis point hike from the Federal Reserve Wednesday, matching the pace of the last two hikes. While a three-quarter point hike is expected, bond investors are pricing in a 24% chance of a one-percentage-point hike. Under these outcomes, the benchmark target rate would be raised to either 3.25% or 3.5%.

In the June meeting (which was the last release to include forecasts by FOMC participants), forecasts were for rates to peak next year at around 3.8%. Investors are expecting this to be closer to 5% following last week’s CPI report, which showed consumer prices still climbing.

With the terminal rate rising, the Fed finds itself in a juggling act as it is unclear if it is better to get there faster or more gradually. Larger hikes can get the Fed to the peak rate quicker, but it can also have unintended consequences.

Chief U.S. economist at JPMorgan Chase, Michael Feroli, noted that investors could interpret larger rate hikes incorrectly.

The danger here is that investors could read too much into a larger hike under the assumption that it means rate cuts are coming sooner than originally expected. However, it could just as easily (or perhaps more reasonably) represent the Fed aiming to get to the terminal rate faster so they can sit on it for longer.

This wouldn’t be the first time in recent history that investors read a little too into Powell’s remarks. In July, investors rallied on perceived dovish comments while ignoring that the Fed Chair kept larger hikes on the table. If there is a surprise this Wednesday, be careful of a knee-jerk rally rooted in faux dovishness.

Earnings

Earnings reports, while low in number, could have large impacts on markets this week. Following last week’s very bearish pre-announced results from FedEx (FDX) that spelled trouble for the economy, investors will be anxiously watching out for similar developments.

Lennar (LEN), KB Home (KBH), and General Mills (GIS) are set to report earnings Wednesday, while Costco (COST) is set to deliver its report Friday. FedEx reports officially on Friday, however, given its pre-released report, any surprises will likely be found on the earnings call side, rather than the report.

Homebuilders Lennar and KB Home should have really interesting reports, as material costs remain elevated and rising rates dampen home buying spirit. Despite this, both of these companies had optimistic outlooks last quarter as buyers still had down payments and good credit scores.

The interesting thing will be, how much these companies change course - if at all - from those comments. FedEx noted that volume trends “significantly worsened” later in the quarter.

While homebuying and having goods delivered are very different businesses, FedEx’s report could underscore a broader trend of consumers pulling back on discretionary spending. After all, the recession-related phenomenon that refers to the substitution of larger purchases with smaller ones is called the lipstick effect, not the “build me a new home” effect.

General Mills and Costco should be noteworthy reports as well. In recessions, people move away from name-brand products for private labels, or store brands. During down times, consumers trade down, and in this inflationary environment, people are really trading down as Morgan Stanley notes that 64% of consumers traded down in July vs 53% in June.

General Mills, the maker of Cheerios, Bisquick, and Haagen-Dazs, is about as name-brand as it gets. So that trend is not good for GIS investors.

Costco investors, however, may have a different interpretation of trading down following Kroger’s (KR) report last week, which showed Kroger’s private label brand “Our Brands” outpace overall same-store sales growth with a 10.2% jump.

Costco amassed about a quarter of its sales from its private label “Kirkland Signature”. With more people looking for deals now than before, General Mills’ woes could be spoils for Costco investors.