Stock Rally Hits a Wall in Run-Up to Fed Decision

Alicia Levine, Head of Investment Strategy and Equity Advisory Solutions at BNY, discusses her S&P target and the sustainability of the equity rally.

Wall Street traders gearing up for the Federal Reserve decision refrained from making big bets as they awaited clues on the path of rates that will shape the outlook for markets over the next few months.

A solid reading on retail sales did little to move markets, with equities wavering near all-time highs and bonds yields barely budging.

The value of retail purchases, not adjusted for inflation, increased 0.6% after a similar gain in July. The control-group sales — which feed into the calculation of goods spending for gross domestic product — climbed 0.7%, indicating a healthy quarter.

“The American consumer appears to be in good spirits,” said Ellen Zentner at Morgan Stanley Wealth Management. “That’s good news for the economy, but it may heighten debate over how aggressively the Fed needs to cut rates.”

While Fed officials are still focused on bringing inflation to their target, they’re widely expected to cut rates in an effort to shield the labor market from further deterioration.

“Even if the job market is weak, it’s not hurting the consumer yet,” said David Russell at TradeStation. “While these numbers won’t prevent the Fed from cutting rates tomorrow, they reduce some of the longer-term dovish hopes.”

The S&P 500 held near all-time highs, with the Nasdaq 100 rising for a 10th consecutive session. The yield on two-year Treasuries was little changed at 3.53%. The dollar fell.

To Bret Kenwell eToro, given the recent labor market data, retail sales were a big question coming into this week.

“In other words, would the recent job weakness impact consumer spending? The short answer appears to be no,” he said.

Kenwell noted that earnings estimates continue to move higher and consumer spending remains solid. Provided these tailwinds remain in place, equities can continue to perform well, even if the market takes a breather, he said.

Following the retail sales data, Jeff Roach at LPL Financial now expects third-quarter GDP to hold above 1%, quarter over quarter.

“Further, it’s important to note that historically, risk assets perform well when the Fed starts cutting rates in non-recessionary environments,” Roach noted.

While retail sales was another piece of good economic news, much of the recent equity rally has been driven by expectations of six rate cuts over the next 12 months, according to Florian Ielpo at Lombard Odier Investment Managers.

“These six cuts can only come if the job market deterioration is material and the equity performance that came with it is dependent over it,” he said.

With the Fed’s post-meeting statement set to be released at 2 p.m. on Wednesday, investors will look for changes in the latest quarterly rates projections, known as the dot plot, and pore over Chair Jerome Powell’s remarks a half-hour later.

Swaps are fully pricing in a quarter-point Fed reduction. Roughly 150 basis points of cuts are projected over the next year. An outlook echoing that view would be an encouraging sign for stock bulls, who have largely banked on a gradual easing path that keeps the economy from sliding into a recession.

The equity options market is predicting a roughly 0.7% swing following the Fed meeting on Wednesday, tied for the second lowest expected move in the last 18 months, according to data from Susquehanna International Group.

“We expect a 25 basis-point cut this week to be followed by three more cuts of the same size consecutively in the coming months, creating a favorable backdrop for the equity rally,” said Ulrike Hoffmann-Burchardi at UBS Global Wealth Management

Bank of America Corp.’s latest survey showed a net 28% of global fund managers are overweight equities. Opinions about growth showed the sharpest improvement in almost a year.

There are “bulls galore” as the risk of a “recessionary trade war” has ebbed, strategist  Michael Hartnett. wrote in a note. He added that equity exposure isn’t at extreme levels yet, which bodes well for the rally to continue for now.

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