Fed rate hikes putting pressure on corporate earnings with investors expecting a worsening outlook

By José Torres

Corporate earnings face a growing challenge with today’s Producer Price Index (PPI) showing persistent inflation, especially within services, at a time when consumer spending is slowing. Stock market investors responded to a worsening outlook for earnings and inflation by selling equities, with most broad indexes declining and yields rising, albeit modestly.

November Producer Price Index (PPI) report continued to weigh on the equity market’s (S&P 500) recent downtrend from its 200-day moving average. The PPI came in hotter than expected, 7.4% year-over-year (y/y) and 0.3% month-over-month (m/m), versus the consensus expectation of 7.2% and 0.2%.

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When excluding food and energy, the Core PPI came in even hotter than headline relative to consensus expectations. Core PPI came in at 6.2% y/y and 0.4% m/m, hotter than the expected 5.9% and 0.2%. While non-core PPI rose at the same pace as October, core PPI accelerated significantly, from 0.1% to 0.4%.

The Preliminary University of Michigan Consumer Sentiment release for December was 59.1, with better-than-consensus expectations of 56.9 and an improvement from November’s 56.8 level.

PPI and Consumer Sentiment data add growing concerns for investors, who are already focused on persistent inflation and an uncertain outlook for the extent of monetary policy tightening during the coming months.

In recent comments, Federal Reserve Chairman Jerome Powell hinted that the central bank may moderate its aggressive pace of fed funds rate increases, which shored up optimism that monetary tightening may have a less dramatic impact on corporate earnings and may be less likely to spark a recession.

As investors fret over threats to margins resulting from accelerating services inflation, wage pressures and weakening consumer spending, many will be sitting on the edge of their chairs during the Federal Reserve’s (the Fed) meeting scheduled for this coming Wednesday.

The big question will be if the Fed believes it’s made enough progress in battling inflation to ease off its monetary policy tightening or if persistent price increases as illustrated by the PPI illustrate that the Fed clearly isn’t out of the woods yet and must continue with aggressive rate hikes that when combined with weakening consumer spending and wage pressures could be a painful hit to corporate earnings.

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(Author is Senior Economist at Interactive Brokers)