Stocks Rally as Traders Pare Aggressive Rate Hike Bets; US GDP Contracts Again

Key Points

• Major US indices rallied again on Thursday as weak US GDP data saw markets further reduce Fed tightening bets.
• The US economy contracted for a second successive quarter, meeting the classic definition of recession.
• The S&P 500 was last up 1.1% above 4.050 while the Nasdaq 100 was last up 0.6% near 12,700.

Dovish Fed Bets Support Stocks

Major US indices rose on Thursday as investors interpreted data showing that the US economy contracted for a second successive quarter in Q2 as lessening the outlook for further rate hikes from the US Federal Reserve for the rest of 2022 and early 2023. Real US GDP was revealed to have contracted at an annualized pace of 0.9% in Q2 after contracting at a rate of 1.6% in Q1. Two consecutive quarters of negative growth meet the classic definition of a “technical” recession.

Fed funds futures markets are now priced for the Fed’s benchmark interest rate to peak this December at just 3.24%, less than 100 bps above current levels. On Monday, prior to the Fed’s “dovish” 75 bps rate hike on Wednesday and Thursday’s ugly growth figures, money markets were priced for rates peaking at 3.39% next February.

Money market pricing also implies a 74% chance of a 50 bps rate hike in September, according to CME, versus a 26% chance of a 75 bps rate hike. One week ago, the likelihood of a 50 bps rate hike was seen at around 40%, while the implied odds of a 75 bps move were at 47%.

Markets are sending a message – they think the Fed will get much more dovish in the coming months as the realities of the weak US economy bite and stocks seem to like the idea of a friendlier Fed. Looking ahead, data on Friday will further inform investor expectations regarding the US economy and Fed policy. US PCE Price Index figures for June will be released and are likely to show that core price pressures remain below their peak hit earlier this year.

Employment Cost Index data for Q2 is likely to show a slight deceleration in the pace of wage gains, which should ease Fed concerns about the tight US labor market’s contribution to current elevated inflation. Meanwhile, Personal Income and Spending growth figures for June will give an update as to the health of the consumer at the end of Q2. The playbook for Friday’s data likely remains the same as on Thursday – weaker data may well support further stock market upside, if it results in a moderation of Fed tightening bets.

S&P 500 Rallies 1.1%, Nasdaq 100 Gains 0.6%

The S&P 500 was last trading with gains of around 1.1% on the day in the 4,050 regions, with the index printing fresh six-week highs and bulls eyeing a test of early June highs in the upper-4,100s. The Nasdaq 100 index was also higher, but only by about 0.6%, with the index failing to break above recent highs in the 12,700 area. Sharp post-earnings losses in index heavyweights Meta Platforms and Qualcomm weighed on its upside.

Meta Platforms reported another quarter of big losses on its metaverse-focused Facebook Reality Labs division and posted its first-ever quarterly drop in revenue. Meanwhile, Qualcomm outlined a downbeat outlook and warned that a slowdown in global mobile phone demand could hit its main chip-making business. Apple and Amazon will be posting Q2 earnings after the close.

The Dow Jones Industrial Average rose 1.1% and, like the S&P 500, also broke out to fresh six-week highs. Thursday’s sharp drop in US bond yields as investors moderate Fed tightening expectations helped support outperformance in the S&P 500 Utilities and Real Estate GICS sectors. Communications Services was the only of the eleven GICS sectors in the red, amid the aforementioned losses in Meta Platform’s share price.