How Stock Markets Will React After FOMC Announcement

For weeks, stock markets anticipated that inflation rates were too strong to expect interest rate cuts anytime soon. This view is a sharp reversal from late 2023 when investors expected several interest rate cuts throughout 2024.

From April 30, 2024, to May 1, 2024, the Federal Reserve will host its next Federal Open Market Committee (“FOMC”) meeting. Markets widely expect the Fed will retain its target rate of 5.25% to 5.50%. Given the Fed uses monetary policy tools to achieve its 2.0% inflation rate target, it will not consider fiscal policy. Despite the massive $95 billion aid package the U.S. House passed on April 20, 2024, its impact on inflation is out of scope for the FOMC this week.

If markets already have a good handle on the Fed’s actions this week, why should investors tune into the event? Fed Chair Jerome Powell will offer the markets any new insight. From the press conference transcript, Powell will say “My colleagues and I remain squarely focused on our dual mandate to promote maximum employment and stable prices for the American people.”

He will announce, “The FOMC decided to leave our policy interest rate unchanged and to continue to reduce our securities holdings.” What might change this time is the commentary on recent indicators. In March, economic activity expanded after the Q4/2023 GDP came in at 3.2%.

Stagflation Risks

In the first quarter, the U.S. Department of Commerce reported that GDP increased at an annual rate of 1.6%. This trailed the consensus estimate of 2.3% and is lower than Q4/2023. In the period, personal consumption expenditure grew by 2.5%. The core PCE price index, which the Fed prefers since it excludes the price volatility in food and energy, increased by 3.7%.

Readers should not expect Fed Chair Powell to mention stagflation, where inflation rates are high and economic growth rate slows, in its press release. Instead, look out for the media to raise it in the question and answer session.

Investors need to dig far deeper than both the official economic data releases and the economic indicators and inflation trends that the Fed monitors. The Fed will watch for monthly inflation rate changes, employment strength, global economic conditions, and financial stability. Investors should critically assess the consumer’s spending strength.

In March, consumer spending, which accounts for over two-thirds of U.S. economic activity, remained healthy. It increased by 0.8% in March. Investors will need to watch consumer spending trends in the second quarter. So far, consumption levels are rising while savings rates continue their downtrend that began in 2023:

According to Bank of America, households should benefit from tax refunds. The average refund increased by 5% this year. Consumer credits are steady, with total outstanding credit mostly unchanged since 2022:

Although the data above shows that consumers are not yet tapped out, that depends on the income group. Consumer delinquencies are a concern for those earning less than $45,000. In its first quarter of 2024, JPMorgan (JPM) took a $2 billion net charge-off. Still, credit card delinquency rates improved last month.

Bank of America (BAC) recorded a $1.5 billion net charge-off.

However, it increased by $306 million from the fourth quarter due to credit card seasoning and commercial real estate office exposure. In its slide deck (slide 10), the bank posted $1.0 billion in consumer net charge-offs, due primarily from credit card losses:

Strong Job Market

The FOMC will cite the robust March 2024 job report, in which the economy added 303,000 jobs. On April 3, Powell described the healthy labor market as “strong but rebalancing.” Additionally, inflation is moving toward the 2.0% target on a “sometimes bumpy path.” Together with the March PCE Price index of 2.7%, the Fed will not change its interest rate target this week.

Stock Market Reaction

Instead of reacting to the FOMC’s statement this week, markets will continue to make investments based on fiscal policy. The continued defense spending assures that RTX (RTX), Lockheed Martin (LMT), General Dynamics (GD), L3Harris (LHX), and Northrop Grumman (NOC) will post outsized profit growth. Rolls-Royce (OTCPK:RYCEY) posted strong profits after benefiting from strong demand for jet engines. Profits more than doubled to £1.59 billion while free cash flow topped £1.3 billion.

Although the defense contracts except Rolls-Royce trade at unfavorable valuations as shown below, investors should weigh the importance of their strong growth and profitability grades.

Northrop and RTX also have strong EPS revision grades of B+.

Your Takeaway

Markets are responding bullishly to the U.S. government spending levels by bidding stock valuations higher. The S&P 500 (SPY), Nasdaq (QQQ), and small-cap Russell 2000 (IWM) are not concerned about rising yields. Treasury yields are now at or above 5.0% for all maturities except the 30-year Treasury (US30Y) and the 10-year Treasury (US10Y).

Speculators who bet on rates falling lost 5.9% in the last month holding the 20+ Year ETF (TLT).

Bond investors should avoid longer-dated debt. The short-term bill yields between three months (US3M) and six months (US6M) are more appealing at 40 basis points above 5%.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.