Markets remain reactionary to Fed policy

Thoughts

• Equity markets look to rebound following the sharpest weekly decline since February. The S&P 500® Index fell 2% last week after closing at a record high the previous week on incremental hawkishness from the Federal Reserve. The Dow had its worst week since October at -4%, while the NASDAQ was little changed. Investors quickly began to price in a peak in Fed dovishness, along with the reflation trade and economic growth. Technology and growth names were resilient, with notable weakness in commodities, financials, and cyclicals. The dollar index saw the largest two-day surge in a year, while commodity prices were hard hit on the risk-off trade. Given the sharp reaction in investor emotion, a 2% decline in equities is modest but the internal trends were notable.
• Fixed-income investors also reacted sharply, as the 10-year Treasury yield fell to the lowest level in nearly three months at 1.45%, now down 0.30% from late March. The 10-year yield has dropped in five-straight weeks, the longest stretch in nearly two years. Shorter rates rose, resulting in a “bearish flattening,” indicating fear of a policy mistake by the Fed.
• Action in the capital markets last week is a reminder of how much influence the Federal Reserve has on the equity and bond market.

News

• Last week’s FOMC meeting saw a shift in the Fed’s approach, with policymakers addressing the eventual taper of $120 billion in monthly asset purchases. Many expect the official announcement to happen in August at the annual symposium at Jackson Hole with actual tapering to begin next year. Additionally, officials shifted upward the expectations for inflation this year by 1% to 3.4% and shifted the outlook for the initial rate hike into 2023 from 2024. The economy is expected to rebound to 7% this year, while the unemployment rate is seen at 4.5%. The Fed is likely to remain in focus this week, with speeches by seven Fed officials this week and congressional testimony by Chair Powell on Tuesday.
• As the economy continues to reopen, many are wondering what the new “normal” will look like. A Washington Post poll indicated a permanent shift in aspects of our lives, including permanent or hybrid work-from-home arrangements, online purchases of everyday items. Workers are requiring increased pay and improved working conditions, while a record number of retail workers are quitting. JPMorgan expects consumer spending up 20% in the second half, driven by encouraging credit card trends, strong retail sales, and the recovery in travel and entertainment. Mobility data shows that time away from home remains nearly 5% below pandemic levels, with retail stores and restaurants down 3% and workplace down 25%.
• Infrastructure discussions will continue this week on the $1.2 trillion bipartisan framework ($579 billion in incremental money) backed by 21 moderate senators. Democrat leaders are expected to move ahead a larger, party-line bill through reconciliation. Senator Sanders reiterated that it needs to address issues like climate, healthcare, and childcare, while opposing a gas tax or a fee on electric vehicles. There is, however, disagreements among Democrats, with some facing tough races in 2022 pushing for a bipartisan solution.

What to Watch

• Economic data this week include existing home sales on Tuesday, new home sales on Wednesday, May durable goods and the PCE deflator (inflation metric preferred by the Fed) on Thursday, and personal income/outlays and consumer sentiment on Friday.