Prior to the recently announced consumer price index (CPI) report, which delivered no unpleasant surprises, at least one Federal Reserve governor had suggested the central bank may be done with its rate hike cycle.

While the decline in inflation is a positive, the Fed’s jawboning is equally important, because it may signal that a change in policy is approaching.

According to CNBC, Philadelphia Fed President Patrick Harker, in a recent speech in his home town, noted: “I believe we may be at the point where we can be patient and hold rates steady and let the monetary policy actions we have taken do their work.” He also emphasized the central bank is not likely to lower rates anytime soon.

As would be expected, Harker hedged his bets by referring to the possibility that any new negative inflation data could certainly change his mind.

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Yet, there it is. A Fed governor is talking about the end of the rate hikes. And he did so three days before CPI showed that inflation continues to slow.

The reason Mr. Harker’s remarks are meaningful is that people in government rarely speak plainly, unless they mean business. Let’s go back a couple of months.

Way back in May, when no one thought the price of oil could ever rise again, I wrote: “Those who are bearish on crude oil may face a rude awakening, at least according to a recent announcement by Saudi Oil Minister Prince Abdulaziz bin Salman, made during the Qatar Economic Summit in Doha on 5/23/23. The oil sheikh told oil market speculators to ‘watch out’ ahead of the upcoming OPEC+ meeting scheduled for 6/4/23. I can’t remember the last time I read such a headline.”

Since then, the price of West Texas Intermediate crude (WTIC) gained as much as $15 per barrel. In addition, as production has slowed, it looks as if the White House has decided to start replenishing the U.S. Strategic Petroleum Reserve (SPR), which will likely fuel the gains further.

My point is that it pays to listen, as part of public discourse involves testing the environment for potential future policy via so called trial balloons. The Saudi minister’s mostly unveiled threat was met with skepticism by the markets. OPEC+ followed with a round of supply cuts. Oil prices rose. Those who paid attention to his remarks and acted accordingly made money.

The Fed is clearly trying to gauge how the market will respond to the end of its rate hikes, perhaps sooner rather than later. Once again, it will pay to listen.

What Does the Bond Market Think?

The U.S. Ten Year Note yield (TNX), the benchmark for several key lending rates, especially 30-year mortgages, once again gyrated near 4% on the CPI news, as the indexes for shelter and car insurance remain stubbornly high.

The key number on the top end of the trading range for TNX remains 4.2%, achieved in late 2022. But a few closes below 4% will be reassuring for stocks. A negative surprise on the upcoming PPI number, to be released on 8/11/23, could certainly make things worse for bonds.

 

On the other hand, Mr. Harker may have an inkling as to what’s in the PPI numbers, as he likely had on CPI, or he wouldn’t have stuck his neck out by suggesting the Fed may be done with the rate hike cycle. Moreover, it’s unlikely that he made his remarks without somebody (Mr. Powell) having checked off on it.

An end to the rate hikes is not guaranteed. Aside from the effects on the effects of pending data on the Fed’s decision making process, Mr. Harker is not unopposed. Recent remarks by FOMC member Michelle Bowman certainly suggest the Fed is far from being in consensus about ending the rate hikes.

But the trial balloon has been released. The markets have responded. The Fed’s game is afoot.

The Big Picture in Stocks

The broad market, as measured by the New York Stock Exchange Advance/Decline line (NYAD) and associated indicators is suggestive of a consolidation.

In the short-term NYAD, is testing the short term support of its 20-day moving average, as investors take profits after the recent AI fueled rally. The CBOE Volatility Index (VIX) is off of its recent bottom yet remains fairly subdued which is bullish.

Moreover, NYAD is still above its 50-day moving average while VIX is below 20. As long as those important levels for NYAD and VIX hold, we can approach this market through the lens of a short term correction/consolidation in the context of a solid uptrend. If VIX rises above 20 and NYAD falls below the 50-day MA, negativity could gain speed.

When VIX rises it means that bearish sentiment is rising and that traders are buying more put options than call options. This triggers market makers to hedge their put sales to traders by selling stock index futures. The net effect is lower stock prices as the market adjusts to the decline in the stock index futures.

Meanwhile, the RSI indicator seems to have survived a test of the 50 area, which suggests stocks may attempt a new high in the next few days to weeks. RSI signals an oversold market when it reaches 30.

Sector by Sector

Interest rate sensitive stocks are often reliable predictors about what the Fed may do next. The market’s recent leadership sector, technology, as housed in the Invesco QQQ Trust (QQQ) is already in correction mode and is now testing its intermediate term uptrend at its 50-day moving average.

Much of this decline is due to the retracement of the recent artificial intelligence-fueled rally, as investors reassess the reality of the potential gains in that particular area of the market. Recently negative news about decreasing demand for semiconductors may weigh on tech stocks for a while.

The most interest rate sensitive sector in the stock market is the utilities. But as the price chart for the Utilities Select SPDR ETF (XLU) shows, the utility sector isn’t totally buying into the notion that the Fed is done. In fact, even as bond yields challenge the 4% yield area, XLU remains range bound.

The action in the real estate investment trusts, an equally interest sensitive sector is somewhat better than what’s happening in the utilities.

You can see the iShares U.S. Real Estate ETF (IYR) is well off its recent bottom and is consolidating above its 50-day moving average. Accumulation/Distribution (ADI) suggests short sellers are moving out while On Balance Volume (OBV) suggests that maybe sellers are becoming holders while buyers are waiting for something to happen. Once OBV turns up, IYR will likely move higher.

The homebuilders, as in the SPDR S&P Homebuilders ETF (XHB) is the best performer in the group. This, of course, is due to the supply shortages of homes offering homebuilders lots of bargaining power. Still, investors are taking a wait and see attitude here.

Bottom Line

The Federal Reserve is playing a familiar game with the market, to wit: float the trial balloon and see what happens. The market, in general, responded positively to the good CPI news after initially ignoring the trial balloon.

Interest rate sensitive sectors responded to Mr. Patrick’s remarks more in tune with their own underlying interests.

Utility stocks retained their bearish bent due to uncertainties plaguing the role of renewables on the electric grid and the emerging reality related to future energy costs.

Real estate investment trusts (REITs) seem to have their fingers crossed but are still non-committal. Meanwhile, homebuilder shares remained stable as the supply and demand scenario for housing remains in their favor.

Once interest rate sensitive stocks begin to move decidedly higher, it will signal that the market is betting on an end to the rate hiking cycle.

Nevertheless, it’s clear that the debate about the future of the rate hike cycle is now well in play. And that’s bullish until proven otherwise.

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