Weaker on Debt Uncertainty

Uncertainty over the debt ceiling negotiations weighed on U.S. stocks Friday, but major indexes such as the S&P 500® Index and Nasdaq Composite were still higher for the week. Separately, Federal Reserve Chairman Jerome Powell said the country’s recent bank troubles could mean interest rates might not have to rise as much as previously thought.

Early in the session, the broad S&P 500 briefly touched its highest level since mid-August before turning south after Republican lawmakers walked out of debt ceiling talks with the White House. Nevertheless, the S&P 500 was still up 1.6% for the week and 9.2% so far this year.

Apparent progress on the debt ceiling had buoyed the market—especially mega-cap technology and AI-related stocks—for much of this week, with a little help from some bullish technical developments in charts of benchmarks such as the S&P 500 and Nasdaq-100 indexes, says Nathan Peterson, director of derivatives analysis at the Schwab Center for Financial Research.

However, he cautions the market could pull back as we draw closer to June, a historically weak month for stocks. This year, it also happens to include the Treasury’s apparent deadline for a possible default on the national debt at the beginning of the month, as well as what could be a significant Fed meeting.

“While the near-term momentum still appears to be bullish, price action is ‘stretched’ in technology, which could set us up for a correction, especially as we approach June,” Nate says.

Here is where the major benchmarks ended:

• The S&P 500® Index was down 6.07 points (0.1%) at 4191.98; the Dow Jones industrial average was down 109.28 (0.3%) at 33,426.63; the Nasdaq Composite was down 30.94 (0.2%) at 12,657.90.

• The 10-year Treasury yield was up about 4 basis points at 3.688%.

• Cboe's Volatility Index was up 0.70 at 16.73.

Consumer discretionary led the declines among S&P 500 sectors, reflecting some of the disappointing quarterly results reported by big retail chains this week. Regional banks were also lower. Small-cap stocks continued to lag behind bigger companies, with the Russell 2000 down about 0.7%.

Read all our market commentary on our Insights & Education page, and you can follow us on Twitter at @SchwabResearch.Earnings roundup The following companies reported results over the past day or had large, news-driven stock price moves:

• Deere (DE) reported quarterly earnings of $9.65 per share, more than $1 above Wall Street expectations, on revenue of $17.39 billion. The farm equipment maker also raised its annual profit outlook. Its shares initially rose as much as 4.5%, but then fell victim to the broader weakness and were down nearly 2%.

• Walt Disney Co. (DIS) shares were downgraded to "neutral" from "outperform" by Macquarie Research, which cited "interim uncertainties" relating in part to declining subscriptions to the company’s streaming service, according to media reports. Disney also earlier this week said it was shelving plans to open a new employee campus in Florida. Its shares were down about 2.6%.

• Foot Locker (FL) reported earnings of 70 cents per share, about 11 cents below expectations, on revenue of $1.93 billion, down 11% from the same quarter in 2022 and also short of forecasts. Same-store sales tumbled 9.1%. Shares of the athletic apparel retailer plunged more than 27%. Shares of competitor Nike (NKE), which is expected to report next month, fell 3.5%.

Earnings season is nearly complete, with about 95% of the S&P 500 companies having reported results in recent weeks. A few more major retailers are expected to report earnings next week, including Lowe’s Companies (LOW) on May 23, Kohl’s Corp. (KSS) on May 24, and Costco Wholesale Corp. (COST) on May 25.

Fed pause prospects get boost

With earnings season winding down and the relatively light economic calendar ahead of the Memorial Day weekend, market watchers will likely be keeping a close eye on the debt ceiling talks and the Fed's next potential moves in the coming week.

Hopes that the Fed might pause its rate-hiking cycle and leave rates where they are got a boost Friday from Chair Powell, who said the recent turmoil in the banking sector may have helped tighten credit conditions to the point where growth and inflation could slow.

"Our policy rate may not need to rise as much as it would have otherwise to achieve our goals,” Powell told the panel in Washington. “Of course, the extent of that is highly uncertain.”

Late Friday, the market pegged odds of the Fed keeping its benchmark funds rate at its current range of 5% to 5.25% in June at about 73%, according to the CME FedWatch tool, up from 64% Thursday but down from above 80% a week ago.

"We think a Fed pause is likely at the next meeting, but the door will be open to more tightening down the road," says Kathy Jones, Schwab’s chief fixed income strategist. "The Fed doesn’t want to signal a soft stance in case core inflation stays high. Credibility is a big issue."

Continuing uncertainty over the debt ceiling negotiations may also influence the Fed's thinking, Kathy adds.

How might a U.S. default affect markets? Because it's never happened before, it’s hard to say for sure.

"We believe stock markets would drop as short-term interest rates spiked (in fact, this is already happening for Treasury bills maturing near the expected default date)," notes the Schwab Center for Financial Research. "There would be a drop in the value of the U.S. dollar, and major rating agencies would downgrade the U.S. government's credit rating. It could also mean a long-term rise in the cost of borrowing for the U.S. government, given the loss of its pristine credit history."

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