WBD - Fed Policy Meeting Preview: What To Expect From Powell's Commentary

2023-12-11 07:30:00 ET

Summary

• The Federal Reserve is expected to keep interest rates unchanged, increasing profit-taking selling pressure risks.
• Investors need to carefully assess Fed Chair Powell's commentary on jobs, GDP, and inflation.
• Stock ideas ahead of Fed meeting.

When the stock market reacted positively to the Federal Reserve keeping interest rates unchanged, the meeting taking place on Tuesday to Wednesday introduces some downside perceived risks. The Fed may give the market what it wants, causing a “sell on the news” event.

While 0dte – zero days until expiration – traders may care most about the short term, a sell-off creates an opportunity for long-term investors. If prices fall steeply enough, buy-and-hold investors may more aggressively buy stocks at a bigger discount. How might anticipating no rate hikes cause markets to take profits? Investors need to carefully assess Fed Chair Powell’s commentary on jobs, GDP, and inflation.

Rate Hike Improbability

The CME Group’s FedWatch Tool indicated a 98.4% probability that the Fed will leave the target rate unchanged at the Dec. 13, 2023 Fed meeting . The Fed may state again “the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

The combination of holding rates higher for longer, in addition to reducing its holdings of Treasury securities, agency debt, and agency mortgage-backed securities, will effectively tighten credit conditions.

The probability of keeping rates at 525 – 550 basis points increased from 90.4% over a month ago.

Stock markets are complacent with the impact of tight credit. For example, instead of punishing them for their high debt, investors flocked back to telecom firms like AT&T ( T ) and Verizon ( VZ ). Citing a buyout on the way, Paramount ( PARA ) lifted media firms including Warner Bros. Discovery ( WBD ).

In the last month, investors ignored Comcast ( CMCSA ) and Sony ( SONY ):

Warner Bros. Discovery and Comcast have strong quant ratings while Wall Street analysts like Sony the most:

With no rate hike, Fed Chair Jerome Powell may still incite fear in stock markets. The forward pricing machine already built expected interest rate cuts by bidding stocks higher. The Fed might insinuate pushing out a rate cut beyond mid- to late-2024. If rates remain at 5% throughout next year, highly indebted firms would fall first.

In the REIT sector, investors may take profits in American Tower ( AMT ) after valuations weakened.

Crown Castle ( CCI ) has a “Sell” quant rating. However, its CEO Jay Brown will retire on Jan. 16, 2024. Anthony Melone will serve as its interim CEO. Melone has over 30 years of experience in the telecom industry. Elliott Management’s pressure on Crown Castle may limit any selling pressure from here.

Bond Market

Regardless of Powell clearly stating that rate change considerations occur during the policy meeting, traders will still react through the bond market.

Both the 10-year Treasury bond ( IEF ) and 30-year ( TLT ) will have the highest volatility. The reason is that Treasury auctions occur weekly for the 4-, 13-, and 26-week T-bills.

What matters most is that the yield curve will remain inverted. When short-term debt instruments have a higher yield than longer-term bonds, investors are expecting a recession. This is bad news for the economy but welcome news for stock markets and the Fed. A slowdown would require the Fed to cut interest rates to stimulate the economy and increase jobs. However, the strong NFP report would suggest that the Fed could not cut rates. Wage growth is feeding into persistent inflation.

Powell’s Commentary

Powell will likely comment on three aspects of the economy on Wednesday.

1. Jobs Report

Fed Chair Powell might dismiss the falling employment rate due to the strike ending in the automotive sector. This would support no rate hike and rate cuts sooner. In addition, the government, not the private sector that concerns the Fed, added 49,000 jobs in November. Looking ahead, after the Hollywood strike ended, it would add jobs to the next nonfarm payroll report.

Powell might raise a red flag to wage inflation. Last month, average hourly earnings increased by 0.4% to $34.10, up 4.0% over the last 12 months. This increases the difficulty in the Fed’s mandate to lower inflation to the 2.0% target.

2. Hot GDP Growth

The BEA posted a sharp 5.2% increase in real GDP + in the third quarter, above its advanced estimate of 4.9% . It increased from higher consumer spending and inventory investment. Imports also increased.

The Fed has plenty of room to slow the economy enough to achieve its 2% target inflation. Demand pressures remain too strong to justify lowering rates in the short term.

Investors should favor companies with strong pricing power. For example, Lockheed Martin ( LMT ), a defense contractor, Nvidia ( NVDA ), an artificial intelligence chip supplier, Altria ( MO ), a tobacco firm, and McDonald’s ( MCD ), a restaurant chain, are firms to consider. Markets seem to prefer Chipotle ( CMG ) over McDonald’s and Starbucks ( SBUX ). The YTD chart below excludes NVDA stock since its outsized gain of 225% skews the relative returns:

3. Inflation

Chair Powell will emphasize the November CPI data in addition to the zero inflation report in October. He will comment on the impact that falling mortgage rates may have on home prices. That might stimulate home demand, raising shelter inflation. The Fed Chair might cite the benefits of low energy prices. However, global events like China’s economic slowdown are also lowering U.S. inflation rates.

Investors may bet that China will cut lending rates and print money to stimulate its economy. That would push oil and gas integrated firms like Exxon Mobil ( XOM ) and Chevron ( CVX ) out of their 52-week lows.

Your Takeaway

Fed Chair Powell’s answers to the media after the policy statement will likely move the markets the most. Stocks already priced a no-rate hike scenario. Should the Fed reaffirm hawkishness to keep rates higher through 2024, traders may sell stock. The U.S. dollar ( UUP ) would strengthen, debt-heavy firms would fall, and interest rate-sensitive stocks would also decline on Wednesday.

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