Volatile markets are worried about more aggressive Federal Reserve rate hikes, but the bigger fear is what earnings season will tell investors about the profit outlook and the potential for recession. Stocks were lower Thursday. Treasury yields edged higher as traders bet the central bank could raise interest rates by as much as a full percentage point later this month. Bond yields rise as prices fall. “Basically it’s like looking across the valley. Are we at the worst point right now and will things start to get better?” said Sam Stovall, chief investment strategist at CFRA. “If the market believes the Fed is hiking by 1 percentage point and going forward it’ll be by 75 or 50 [basis points] or whatever and leading to a Powell pause, then the market would feel encouraged.” A basis point equals 0.01%. The market has speculated that Fed Chair Jerome Powell may be forced to pause by a faltering economy, if the central bank carries out more aggressive rate hikes upfront. But with JPMorgan Chase and others beginning to report earnings, Stovall said the market is actually more worried about the potential for cautionary comments from companies and earnings downgrades. JPMorgan’s stock fell about 3.5% after the bank reported a surprise 28% decline in earnings Thursday morning. “Right now, I think the market is, yes, concerned by interest rates, but I think it’s more concerned by earnings. What we do know is the analysts haven’t really done anything in terms of reducing their forecasts,” said Stovall. Prepping for an aggressive Fed The Fed last raised its fed funds rate by a full percentage point back in the 1980s after former Fed Chair Paul Volcker famously ran the rates up to 20% in his battle against inflation. At the time, the central bank did not reveal what moves it made with regards to the fed funds rate. Former Fed Chair Alan Greenspan instituted the Fed’s policy of targeting the rate in the 1990s, and since then there have been no rate hikes as large as a percentage point. The Fed last month raised rates by 75 basis points , and markets were bracing for another similar hike until Wednesday’s report of hot inflation in June ratcheted up expectations for an even more aggressive Fed action. That three-quarter point increase was the biggest hike since 1994. The benchmark fed funds rate is currently targeted to a range of 1.5%-1.75%, the highest since just before the Covid-19 pandemic began in March 2020. Strategists said the market has been adjusting this week to a more aggressive Fed, and the concerns that a heavier-handed central bank could tip the economy into a recession sooner than some had expected. The fed funds futures began pricing in the chance of a full percentage point hike after Wednesday’s report that the June consumer price index rose 9.1%. On Wednesday, expectations of a full percentage point hike were near 70%, based on fed funds futures. But by Thursday afternoon, the futures market was forecasting just about a 35% chance of a 100 basis point increase, according to Peter Boockvar, chief investment officer at Bleakley Advisory Group. On Thursday, comments from two Fed officials cooled those expectations. Fed Governor Christopher Waller said he was in support of a 75 basis point hike, and St. Louis Fed President James Bullard also said he supports that level. “I think it would make a lot of sense to go with the 75 at this juncture,” said Bullard, a Federal Open Market Committee voting member this year. Fed funds futures for July were pricing 83 basis points of a hike after the comments, down from 93 late Wednesday, Boockvar noted. Managing earnings season and the Fed “I think JPMorgan is a reminder that the next six weeks of earnings are going to be really bumpy. It’s not just JPMorgan. [Wednesday], you had Fastenal that got whacked. We’re dealing with revenues slowing on top of profits slowing down,” said Boockvar. “You’re juggling both things — what the Fed’s doing and how we’re going to maneuver through earnings season here on top of a liquidity squeeze from a strong dollar. A strong dollar is just a tightening of financial conditions.” Should the Federal Reserve decide to raise the fed funds target rate by a percentage point, strategists point out there is no clear comparison between the 1980s and now. The market may also not be as surprised as it might have been previously. “I don’t know if it’s going to be that much of a shock,” said Chris Rupkey, chief economist at FWDBONDS LLC. “We already went through this a month ago. The Fed more or less promised 50 basis points. They got a hot [consumer price index] report and then went with 75. It’s happening again. Fed gets a bad inflation report, even worse than the last one so instead of going the expected 75, they go 100. … I don’t know if anyone’s going to be shocked,” Rupkey said. John Briggs of NatWest Markets looked at moves of 1 percentage point or more during the 1980s in the fed funds rate. He said the final move of a percentage point appears to have been between February and March 1984, when the fed funds rate went to 10.5%. “In that time frame, the market went sideways,” he said of the March period. The S & P 500, for that year, was up 1.4%. The market’s reaction is unfolding Paul Hickey, co-founder of Bespoke, said the market reaction to a possibly more aggressive Fed is already happening. “Look at the market over the last five weeks,” he said. “The fact that the rate hikes are coming in such a speed and magnitude is something the market has a tough time digesting.” But he added, there’s really no precedent for the post-pandemic rate-hiking era. “You have to go back to the early ’80s when they were moving by this much, and it was a whole different ballgame. It’s not really apples-to-apples comparisons,” Hickey said. “Every period is different. There was much less focus on the Fed, and moves weren’t telegraphed in advance. You didn’t know what they were doing. It was a whole different structure.” Hickey said the central bank has made it clear it will stick to its rate-hiking course until there is a change in inflation’s path, which so far has not happened. “I think companies are going to be a good guide to see what’s going on in the market. These bank earnings today, they’re being conservative,” he said. “Current conditions aren’t necessarily that bad. It’s a matter of preparing for turmoil ahead. People think things are going to get worse. Whether that materializes remains to be seen.” Stovall said he is waiting to see more earnings misses and more downward revisions. He said already earnings expectations for the second quarter, just now being reported, are declining. For the period, analysts had expected profit margins of 13.9% as of June 30, but now those expectations have fallen to 13.1%. Those downward revisions could make for more volatility in the stock market. “I think the S & P has to go to at least 3,500, or even 3,200. If the S & P hits 3,200, that’s an average bear market,” he said. He said at 3,200, it would be a 33% decline, and at 3,500, he would become more comfortable buying. The S & P 500 ended Thursday’s session at 3,790.38, slipping 0.3%.
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