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Fed dovishness drives markets to record highs

August 31, 2020


  • Equity markets continued their march higher, with the S&P 500 IndexTM and the NASDAQ at record highs. The S&P 500 has seen two six-day winning streaks this month for the first time in history despite August being a weak seasonal month. The index has seen five-straight weeks of gains and will close August with the fifth-straight monthly gain, registering the best August since 1984.
  • Despite the unprecedented period of volatility, the S&P 500 has returned 9% this year and 22% over the past 12 months. While growth and momentum names continue to be the primary driver of returns (NASDAQ up 30% YTD), value and cyclicals have begun to participate. Bank stocks are among the recent winners, as the long-end of the curve has jumped to the highest level since June (10-year at 0.74%) and the yield curve has steepened following the Fed’s commitment to keeping the Fed Funds steady for the foreseeable future.
  • In addition to the Fed’s liquidity, coronavirus optimism, positive economic surprises and resilient corporate earnings, the weakening dollar (down 10% since March) has been a tailwind for the market. Foreign investors are expected to allocate $300 billion to the U.S. this year per Goldman Sachs. Additionally, for each 10% decline in the dollar, S&P 500 earnings show a boost of 10%, led by technology, materials and energy. The ultimate downside to a strong dollar, however, is inflationary pressure, as expectations have bounced in recent months.


  • The Federal Reserve announced a fundamental shift in policy last week, shifting to an average inflation target of 2% and expressed willingness to overshoot the goal. It also adjusted its view of full employment to allow the job market to run hotter and to drive wage gains. The Fed first adopted a 2% target for inflation (measured by core PCE deflator) in 2012, though over the 103 months since the 2% target was breached only 12 times with an average of 1.4%. With the Fed Funds rate at zero and the balance sheet having grown by nearly $3 trillion this year, skepticism is growing around the Fed’s ability to drive inflation.
  • White House Chief of Staff Meadows met with House Speaker Pelosi last week, though they failed to make any breakthroughs. Pelosi said Democrats were willing to come down to ~$2.2t from their prior compromise offer of ~$2.5t, while the White House moved up to $1.3t from ~$1.0t. Continued market strength and positive economic surprise momentum has dampened the sense of urgency. A deal will likely be tied to a stopgap funding package to avoid a government shutdown by October 1. Recent polls suggest the race for President is tightening, with the betting odds show Biden down to 51% from 61% a month ago, and polls in battleground states indicating the lead is less than 3%.
  • Worries about the trajectory of the recovery and the lasting damage is forcing several large companies to shift staffing plans. In the past week, MGM Resorts, Coca-Cola, Salesforce, United Airlines, American Airlines and Bed, Bath & Beyond announced permanent layoffs. The expiration of PPP loans is impacting small businesses, driving unemployment claims to more than one million for the 22nd time in 23 weeks. This is a headwind to the economy that saw impressive spending, income and housing data last week.

What to Watch

  • Economic releases include ISM Manufacturing on Tuesday, durable goods and the Fed’s Beige Book on Wednesday, ISM Non-manufacturing on Thursday and monthly payrolls on Friday.

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