2023-05-02 12:50:52 ET
Summary
- Traders price in a 94% chance of another Fed rate hike on Wednesday afternoon.
- There is a 1-in-3 chance of a June increase with a terminal rate near 5.12% in Q3.
- I am bullish on lower Treasury volatility ahead, which may benefit the popular dividend growth ETF, DGRW.
The Federal Reserve begins its 2-day policy meeting today. With improving inflation trends, but a still warm (though less hot) jobs market, Chair Powell and the rest of the FOMC continue to work a balancing act to hit its dual mandate of price stability and maximum employment.
On Wednesday, there will be no dot plots or outlook, making the 2:00 p.m. ET rate decision and 2:30 p.m. ET press conference all the more critical.
As it stands, the market anticipates a high 94% chance of another quarter-point hike. The terminal rate is seen hitting 5.12% in the third quarter. The consensus is for a 'hike and hold' with an extended period of a 5%-plus Fed Funds rate through October. The first rate cut is not priced in until the November 1 decision date.
By this time next year, however, the rate may be a full percentage point lower. Jump ahead to late 2024, and money market yields could be close to 2.5% if the futures curve plays out.
'Hike and Hold'? Just a 1-in-3 Chance of a June Rate Increase
With a 65% chance of a recession, according to BofA Global Research, the Fed cannot be too aggressive in its rate hike cycle. So, one more hike is probably appropriate, but the market has discounted about a 1-in-3 probability of an additional rate increase on June 14.
Recession Risks Seen at 65%
As if there was not enough for the FOMC to weigh, Treasury Secretary Janet Yellen came out last night warning that the U.S. could default on its debt as soon as June 1 - before the June 14 meeting. I expect Powell to be asked about how the looming debt crisis may impact monetary policy in the near term.
More Debt Ceiling Volatility Ahead?
This week features a ton of key data, too. JOLTS numbers came out today, Apple earnings cross the wires on Thursday afternoon, and the pivotal April jobs report hits Friday morning. The Fed will not have access to the payrolls report by Wednesday afternoon - a few select members can peek at the employment situation for last month Thursday night, but not before. Warren Buffett will likely assuage investors at the Berkshire Hathaway annual shareholders meeting Saturday at "Woodstock for capitalists." But then comes the April CPI report on the 10th.
Amid all that, you would think volatility would be shooting higher. Nope. The VIX ended Monday barely above 16. Implied volatility that low suggests just a 1% daily change in the S&P 500, below the historical average. So, investors appear comfortable with where things stand despite the macro fears and scary headlines.
VIX Falls Under 17
Perhaps a strong earnings season has helped assure market participants that companies can navigate today's challenges with relative ease. We are near halftime in the first quarter earnings season, and results have been much better than expected: "So far, actual results came in a very strong +6.8% above expectations at the start of the season (for investment grade companies) - better than -0.6% surprise in 4Q and +3.7% pre-Covid average," according to BofA.
Much Better Than Expected IG Earnings in Q1
What is not stable, however, is the interest rate market. The ICE BofAML MOVE Index ((MOVE)) remains in extreme territory near 130 - a multiple of 8 compared to the VIX's tame level. That is the biggest gap we have seen in the last decade.
The MOVE-to-VIX Ratio Near Cycle Highs
I will be watching how MOVE 'moves' over the coming weeks after this onslaught of earnings reports and economic data. If a Treasury default is avoided and inflation continues to retreat, reduced rate volatility would instill confidence in the corporate world, particularly for debt-reliant firms in value sectors.
That leads me to this week's ETF focus. The WisdomTree U.S. Quality Dividend Growth Fund (DGRW) is a popular way for income investors to own dividend-growth firms. The ETF seeks to track the investment results of dividend-paying large-cap companies with growth characteristics in the U.S. equity market, according to WisdomTree .
DGRW: 5-Star, Gold-Rated by Morningstar
With an annual expense ratio of just 0.28% and net assets of more than $8 billion, it is a low cost and liquid fund targeting high-quality income stocks that are hiking their payouts. The 30-day median bid/ask spread is just two basis points.
Ninety-six percent of the ETF is allocated to domestic large caps, according to Morningstar , and the portfolio's price-to-earnings ratio appears lofty at 18.1 on a forward basis, near the S&P 500's 18.2 forecast operating earnings multiple.
S&P 500 Valuation Measures: 1.69% Yield, 18.2 P/E
The dividend yield of 2.0% is only slightly higher than the S&P 500's 1.69% yield as of April 30, 2023. Unlike many dividend funds, DGRW is highly weighted in the Information Technology sector and holds few Energy stocks. Staples, a defensive niche, is an overweight, so there is some ballast in the sector allocation between growth and value. Overall, the top 10 stocks represent 35% of DGRW.
I like DGRW for its mix of growth and value. Lower interest rate volatility in the coming quarters should help companies with their capital allocation decision, and that could bode well for dividend growers held in this ETF.
DGRW: Top Holdings and Sector Weights
The Technical Take
DGRW has outperformed many market indices over several timeframes. Notice in the chart below that shares put in a bullish rounded bottom pattern last year and are just now bucking up against resistance in the low $60s. A bust through $65 would quickly lead to a challenge of the all-time high notched in December 2022 just below $67.
On a total return basis, the fund is just 2% under that peak. I like how the long-term 200-day moving average is upward-sloping, and I see support near $59.
DGRW: Bullish Rounded Bottom, Eyeing the All-Time High
The Bottom Line
With one or two more Fed rate hikes in the cards and key data propping up rate volatility expectations, we could be getting closer to the end of bond market volatility that we have grown accustomed to over the last many quarters.
I like how DGRW sets up here, and its low expense ratio with strong relative performance is an appealing way to play a more certain fixed-income world going forward.
For further details see:
Fed Preview: 'Hike And Hold' Priced In, DGRW Stands To Benefit