Week Ended June 18th 2021: Fed Rattles Markets
Similar to the week before, financial markets lacked direction during the first part of the week, although this mood shifted quickly mid-week following the release of the FOMC minutes on Wednesday and the customary press conference that followed. The FOMC minutes in isolation (here) indicated no change as far as the Federal Reserve’s short-term borrowing rate policy and the magnitude and timing of ongoing bond purchasing (i.e. quantitative easing) programme, which will continue at $120 bln/month. However, Fed chairman Powell provided substantially more colour on the state of the US economy and likely Fed action steps in his press conference. The full press conference is around one hour long and is on the Federal Reserve website here should you wish to watch it. In summary, Chairman Powell said that the US economy is ahead of its growth trajectory due to better-than-originally anticipated results so far in the fight against COVID-19. Key US economic updates included:
PCE Inflation for 2021 was revised upwards to 3.4% (from 2.4% in March), with the Fed insisting that inflation remains transitory,
US real GDP was revised upwards to 7.0% for 2021 (from 6.5% in March), and
Unemployment at year-end was not revised and is still expected to be 4.5%.
You can find the full economic update from June 16th from the Federal Reserve here, noting that the much-discussed “dot plot” is on the fourth page of the Fed’s economic update. I mention this because much of the post-FOMC policy release discussion with Chairman Powell involved questions about the potential timing of the unwinding of monetary stimulus. With the US economy recovering faster than expected, the dot plot suggests that the Federal Reserve will raise its key interest rate (the Federal Funds rate) twice in 2023, which would most likely be preceded by the gradual reduction of bond purchases (known as tapering). This means that a shift towards a more hawkish tone is being brought forward, although Chairman Powell continued to stress that the key focus of monetary policy of the Fed was getting the US economy back to full employment before changing its stance. For some reason, the data seemed to initially shock investors which suddenly went back into the “inflation fear” mode but this did not persist, because by Thursday, cooler heads prevailed and market sentiment seemed to normalise. However, this proved to be short-lived as Friday brought another shift in sentiment that generally raised risk across markets.
As far as the global equity indices that I track, the Japanese stocks market had the best performance for the week (+0.1%), the only global index I track that was positive last week. The worst performer was the S&P 500, which was down 1.9% W-o-W.
In fact, all of the US indices were red for the week, with the relative best performer being the NASDAQ Composite (-0.3%). The index that arguably signals the most about the recovery / reflation trade – the DJIA – was down 3.4% on the week, whilst the value trade also faltered with the Russell 2000 down 4.2% on the week. Even so, the Russell 2000 remains the best performer YtD as far as the US indices, although the NASDAQ has reclaimed the top spot for the second quarter, at least so far.
US Treasury yields increased sharply following the Fed’s press conference mid-week, but then settled as the 10-year Treasury closed the week yielding 1.45%, down 2bps W-o-W. However, the yield increases were firm at the shorter end of the curve, with the 2-year US Treasury closing at its highest yield since April 2020. Perhaps this is not surprising in that the potential increase in the Federal Funds rate has been brought forward. This increase in yields at the shorter end of the curve caused the 2-10 yield differential to continue to narrow, a potential indicator that US economic growth will potentially “normalise” sooner than anticipated. The 2-10 year difference is 119bps, down from a high (steeper curve) of 158bps around three months ago.
Corporate credit was mixed on the week as underlying US Treasury yields gyrated, but yields ended the week slightly higher across investment grade and high yield. See yield update below across the credit spectrum.
I cannot figure out if the price of gold is more influenced by inflation expectations or general market risk, but in either case, the price of the precious metal tumbled last week. The US Dollar has continued to strengthen, likely reflecting the Fed’s comments mid-week as the US economic recovery gains steam, bringing forward a potential shift in monetary policy that would cause yields to increase. WTI crude oil remained firmly above $70/bbl (WTI close at $71.50/bbl), continuing the ascendancy of oil now for many months.
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