For stock market investors, the coming week is likely to see the Federal Reserve move back into focus, stealing the spotlight back, at least briefly, from worries about tariffs and political turmoil.
The Fed’s two-day policy meeting, which will conclude Wednesday and is widely expected to deliver the first rate increase of 2018, will be Fed Chairman Jerome Powell’s first as chairman of the central bank, and investors will be eager to find out just how much he deviates from the legacy of Janet Yellen, whom he succeeded in early February.
While market participants have fully priced in a quarter-percentage point rate increase on Wednesday, investors will parse the wording of the accompanying statement and Powell’s subsequent news conference.
“We want to see if he will do anything out of ordinary. But generally, neither Powell, nor any other Fed chair would want to rock the boat,” said Diane Jaffee, senior portfolio manager at TCW.
Fed funds futures market expects three rate increases by the end of the year, with a more than a 30% chance of four.
But investors continue to be somewhat optimistic and rightly so, according to Jaffee.
“Consumer sentiment, factory order this week and jobs report last week, all point to a growing economy. If the economy runs well, it won’t matter if there are three or four rate increases and some sectors are better poised for such an environment than others,” Jaffee said.
Indeed, the market performance in 2018 proved that investors don’t seem to care about higher interest rates as long as they keep up with inflation.
The yield on the 10-year Treasury note remains below 3%, a level considered moderate.
The February selloff was sparked by fears of inflation after the January jobs report showed a pickup in wage pressures. The subsequent bounceback was fueled by economic data showing prices still aren’t rising too fast.
It is difficult to forecast what the whole market will do over the next 12 months, but certain sectors are better positioned for a rising rate environment than others, according to Jaffee.
“As long as the banks can make loans and make a profit on the spread between deposit and loans rates, banks will be profitable. Though, if interest rates get too high and crack the demand, then the cycle will end,” Jaffee said.
The S&P 500 financial sector has risen 17% over the past 12 months, slightly outperforming the broader market, which is up 15.6%.
“The technology sector has shown it can have organic growth regardless of the economic cycle, while industrials and basic materials will benefit from a 50% jump in the GDP growth if we indeed achieve a 3% rate,” Jaffee said.
According to Atlanta Fed’s GDPNow tracker, the U.S. economy is estimated to have expanded at a 1.8% clip during the first quarter of this year, which is twice the average rate for this period throughout the recovery.
But higher rates are still likely to dent some industries that are seen as bond proxies, such as utilities, telecoms or consumer staples. These sectors have already been underperforming and may continue to do so for some time, according to Jaffee.
Since the start of the year, telecoms, utilities and consumer staples are down between 4.5%-6.5%.
“It is super difficult for utilities and telecoms to grow in the this environment without underlying growth,” Jaffee said.
The Federal Open Market Committee’s two-day meeting concludes Wednesday, with the policy decision due to be announced at 2 p.m. Eastern. It will be followed by Powell’s first news conference as Fed chief at 2:30 p.m.
Apart form the FOMC, investors will get fresh readings in the week ahead on February existing and new home sales and durable goods orders.
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