Stock rebound could continue as long as the Fed doesn't spook markets

19-02-2018

Stock rebound could continue as long as the Fed doesn't spook markets

Stocks could continue to rebound as long as the bond market doesn't get spooked about the Fed in the week ahead and send interest rates higher. After the best week in five years, the stock market has regained about half the 10 percent it lost in a swift February correction due to rising inflation and fears of higher interest rates. The stock market has become more tolerant of rising bond yields, which contributed to its violent sell-off. The bond market has been the stock market's nemesis, with new signs of inflation in wage data and January CPI driving interest rates higher.Now the markets are waiting to hear what the dozen or so upcoming Fed speakers may have to say about inflation. The fear is that Fed officials will be motivated to raise interest rates faster if they start to believe inflation is rising too fast, after rising at a sluggish pace for years. Higher interest rates could then drive investment dollars from stocks, making borrowing costs higher for investors and companies, while rising inflation could eat into profit margins. "Hopefully, it will be a week where we can just stay focused on the fundamentals, and we can watch the market digest real data, as opposed to sentiment, and that would be a good thing," said Kate Moore, BlackRock chief equity strategist.

Besides the Fed speakers, there will be minutes from the Fed's January meeting released Wednesday afternoon. There is also an important report, released at the end of a week that is light on economic reports. On Friday morning, the Fed issues its monetary policy report for 2018, ahead of new Fed Chair Jerome Powell's congressional testimony the following week, on Feb. 28. A fairly dramatic change has come over the bond market, in that it has begun to signal that investors see the Fed raising interest rates for a longer period of time and possibly as many as four times this year. So anything the Fed speakers say about their view of inflation or recent market volatility will be important. "It's going to be tricky for them to pre-empt Powell in the week after. I think they'll roll with the mantra, which is a gradual removal of accommodation remains appropriate and we expect inflation to pick up," said John Briggs, head of strategy at NatWest Markets.

The S&P 500 is now 4.9 percent from its all-time high, after a plunge of more than 10 percent, its worst correction in two years. The S&P 500 was at 2,732 Friday, up 4.3 percent for the week, its best since early 2013. For now, stocks and bonds have called a truce. Traders focus most on the benchmark 10-year Treasury yield, which influences a range of business and consumer loans, including mortgages. The 10-year hit a high of 2.944 percent Thursday but was back to 2.87 percent by late Friday. Marc Chandler, head of foreign exchange strategy at Brown Brothers Harriman, said the dollar will also be important in the week ahead, and it could move higher after a technical break on Friday. The dollar has been under pressure, with the dollar index losing 1.5 percent in the past week. But the dollar index closed up a half percent Friday, just above the important 89 level, the Thursday high. That indicates it could move higher in the near term. "Sentiment is very extended. Technically, the dollar looks like it's making a key reversal against many currencies," Chandler said. But the Treasury market remains front and center with three days of auctions, for 2-year, 5-year and 7-year notes. "Right now, we're working our way through the squall related to rising inflation expectations," said Joe Quinlan, head of thematic strategy at Bank of America Global Wealth and Investment Management. "I would just say we're making that bottom. The key is it's an early warning about the volatility that everyone should expect for this year. Get used to it. It's going to be back," he said. "We're going to have these moves down and up." Quinlan said he could see another significant correction this year. "It would not surprise me, not at all, if we have another correction, or another grinding-down process related to anything around the 10-year yield backing up anywhere near 3 percent plus. That would not surprise me, and investors shouldn't be surprised either," he said. He expects inflation to continue to rise, but not to get too hot.

The focus for markets could also stay on Washington in what will be a four-day week after the Presidents Day holiday Monday. Stocks ended mixed on Friday, after the afternoon revelation that special prosecutor Robert Mueller's investigation led to the indictmentof a group of Russians for meddling in the U.S. election, but the indictments indicated that members of the Trump campaign were not knowingly involved. "I just don't know if we know enough as to whether this brings us closer to a conclusion. Many people have thought the investigation is winding down anyway. We've been waiting for another shoe to drop. Is this the shoe?" said Chandler.