Markets seek to break out of tight range as volatility fades

Thoughts

• Equity markets look to break out of the recent trading pattern, with the S&P 500® Index starting the week mere points below the record high from a month ago. Investors have wrestled over the past two months on the economic reopening and encouraging data versus elevated valuations, supply-chain issues, and an uncertain path for the Federal Reserve. Renewed investor optimism and speculative behavior has driven rallies in pockets of the market but has not led to a broad market breakout of the recent range. The broader market has a more cautious and skeptical tone than earlier in the year.
• Volatility has collapsed in recent weeks, with the VIX below 17 for the first time since before the pandemic. Over the past three weeks, the average daily move for the S&P 500 is just over one-third of a percent, compared with an average of 1.2% since the pandemic. Despite the recent drop in volatility, markets continue to have a subtle pro-cyclical shift, led by value, small caps, and emerging markets. Commodity prices also reflect the risk-on environment, with crude prices and retail gas prices at the highest level since 2014.

News

• May payrolls disappointed for the second-straight month, adding 559k jobs versus the expectation of 650k. The employment-to-population ratio, a metric followed by the Fed, inched higher to 58.0% but remains 3.1% below the pre-pandemic level. The report was another indication of a labor shortage, as the sluggish growth is more attributable to a lack of labor supply rather than demand for workers despite the economy having roughly seven million fewer jobs than before the pandemic. The market reacted positively to the report, as a strong report was feared to potentially trigger a tapering of asset purchases by the Fed.
• The economy continues to run at record levels, with the NY Fed’s Weekly Economic Index reflecting economic growth of greater than 11% for the past seven weeks. May ISM services recorded a record-high 64.0, better than expectations and above April’s reading of 62.7. New orders, backlog, and export orders grew, though supplier deliveries and employment continue to reflect supply chain and labor challenges. Prices paid reached the highest level in 16 years, with all commodities showing inflation. The ISM manufacturing survey showed similar trends, with a reading of 61.2, and prices paid off just slightly from April’s reading that was the highest since 2008.
• Treasury Secretary Yellen supports President Biden’s $4 trillion in additional spending, and if it triggers higher interest rates and inflation it could be a positive given the low levels over the past decade. She continues to believe that the recent inflation pressures are transitory, and that control over inflation rests with the Fed, not the administration. The G7 backed her proposal for a global minimum tax of at least 15%, though the road to passage is long and requires the support of the broader G20 and over 100 other countries in addition to congressional approval. Biden rejected the Republican counterproposal on infrastructure, as a bipartisan solution is proving difficult to execute.

What to Watch

• Inflation data will be in focus this week, with the CPI report for May on Thursday. Other important data points include NFIB Small Business and JOLTS job openings on Tuesday, hourly earnings on Thursday, and consumer sentiment on Friday. The FOMC meeting is the following Tuesday and Wednesday.