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The markets have kicked off August with no sign of summer doldrums. Last week saw big post-earnings moves in some of the stock market’s largest stocks, including Amazon AMZN up 15.3% and Apple AAPL down 9.2%. Meanwhile, bond yields are pushing toward their highest levels since 2023, when inflation pressures were soaring. And this coming week will bring still more earnings and the always-critical monthly jobs data on Friday.
In today’s Markets Brief, we’ll take a closer look at why the bond market didn’t like what new Federal Reserve Chair Kevin Warsh had to say last week, and we sift through the implications of those earnings-triggered outsized price moves in what we might call the Magnificent 6, which have now posted their quarterly results. (We still have nearly a month before Nvidia NVDA reports.)
A Fed’s Inflation Credibility Shock
Even going into last week’s Fed meeting, the backdrop suggested this might not be more than the usual non-event. For some time, expectations of what the Fed will do have usually been nearly unanimous. But this time around, the bond market was split. The CME FedWatch tool put the odds of a rate hike at 40% and the odds of no change at 60%.
The Fed didn’t change rates this time, but that wasn’t what bond market participants focused on. Instead, it was Warsh’s press conference—both what he did and didn’t say—that rippled through the market. In highly unusual fashion for a Fed meeting day, short-term bond yields fell while long-term bond yields rose. In fact, after the press conference, 30-year yields rose to their highest level since 2007. That’s what traders call a “twist steepener” in the depiction of yields across Treasury maturities known as the yield curve.
Why did the market react this way? The decline in short-term yields reflected expectations that the Fed may not raise interest rates as aggressively as expected. Here’s how Bank of America analysts put it: “Warsh evaded a lot of questions but made a few starkly dovish remarks. First, he opened the door for looking at other inflation indicators besides [the Personal Consumption Expenditures Index]. Second, he suggested there could be other tools besides hikes to fight inflation. Third, he implied that markets have done some of the Fed’s tightening work for it.”
Perhaps more significant was the selloff in longer-term bonds, which led the yield on the US Treasury 10-year note to its highest level in a year. One issue is a lack of information about why the Fed didn’t raise rates. (Three of the 12 voting Fed officials wanted to hike.)
“Why didn’t the Fed go ahead and hike? We don’t know,” Morningstar senior US economist Preston Caldwell wrote. “In addition to a lack of information in the policy announcement, Warsh was asked why the majority of the committee decided to stand pat and why the three dissenters argued for a hike. He declined to offer a substantive response to either question.”
Analysts were more troubled by Warsh’s comments that appeared to put into question the Fed’s 2% price target for the PCE. Warsh “paid only lip service to the Fed’s 2% PCE mandate, downplaying his commitment to 2% PCE inflation,” wrote JPMorgan analysts.
“Markets responded by questioning the Fed’s credibility: long-end yields and the dollar sold off substantially,” Bank of America analysts wrote.
Ironically, some economists say the bond market’s reaction could cement the possibility of rate hikes. “We think the need to reestablish credibility increases the probability that the Fed will hike in September, all else equal,” wrote the Bank of America team, which expects the Fed to hike rates at each of its three remaining meetings this year.
Warsh’s posture also ups the ante on good inflation news in coming months, according to Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth. “The fact that the recent [inflation] data is moving in their desired direction buys them some time, but if that trend ends, they’ll have to hike or will lose all credibility.”
The Magnificent Three?
There was a time when the Magnificent Seven—Alphabet GOOGL, Amazon, Apple, Meta Platforms META, Microsoft MSFT, Nvidia, and Tesla TSLA—were all driving higher, dominating the market. That connection has frayed as the group’s returns have lagged. With the release of second-quarter earnings, these stocks are each going their own way.
“Our positioning, broadly speaking, has been that we’re going to start to see a bifurcation among the Mag Seven,” says Sara Araghi, portfolio manager at Franklin Equity. “Some are winning, and some are losing.” The dividing line “has depended on whether companies have demonstrated near-term monetization [of AI], or if they have proof points around their return on investment.”
Two winners, Amazon and Microsoft, had been recent laggards. Amazon jumped more than 15% on Friday, its biggest one-day gain since 2012. “For the first quarter, the market didn’t reward them for quite nice growth, and wanted more. They delivered more, and you’re seeing the margin benefit in AWS,” Araghi says.
Meanwhile, Microsoft just had its best week since 1999. “Revenue growth is accelerating, and product adoption is measurable. They talked about Copilot doubling from last quarter, Azure growth is accelerating, and you don’t necessarily have free cash flow concerns,” Araghi says.
On the flip side, the losers based on the stock market’s response include Meta. “Your fundamentals are pretty strong. You’re seeing your AI benefits in your business, but it’s still a debate on how much you have to increase your capex,” Araghi explains.
Apple has become caught in the crossfire, with supply and memory cost challenges spilling over from the AI buildout. The stock fell 7.5% Friday, its worst one-day drop in over a year.
One Mag 7 name had a change of fortunes on Friday: Alphabet. The stock took a 7% dive on earnings, released July 22, but on Friday, shares jumped by nearly that same amount. The catalyst was actually Amazon’s news, according to Morningstar equity analyst Malik Ahmed Khan. Amazon president Andrew Jassy “made a strong case for AI data center ROI,” he says. “Amazon came out and presented their view on why the spending is value-accretive, but that logic holds for both Amazon and Alphabet.”
The bottom line, according to Araghi, is “you’re seeing a higher burden of proof needed around [AI investment] returns.”
A Big Week Ahead for Economy, Earnings Data
On Friday, investors will shift their focus to the Bureau of Labor Statistics’ July jobs report for clues on where interest rates could end up later this year. Economists expect 100,000 new jobs, according to the FactSet consensus. That would be a faster pace than June’s 57,000 gain in hiring, which was a slightly cooler print after strong job gains earlier this year.
Other new data this week will include earnings results from data and analytics intelligence company Palantir PLTR and Snapchat parent company Snap SNAP, both reporting today. Later in the week, pharmaceutical companies Pfizer PFE and Eli Lilly LLY will report their latest results, alongside healthcare giant CVS Health CVS.
The author or authors do not own shares in any securities mentioned in this article.
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