The Federal Reserve Open Market Committee made no changes in monetary policy today, keeping the target short-term interest rate at 0.00-0.25%. The official statement was little changed in substance, with wording about the hardship caused by the Covid-19 pandemic replaced by the improvement due to wider vaccinations.
The most recent Fed member estimates (seen in the ‘dot plots’) point to a greater chance of a rate hike or two by 2023 than the previous March plot. (This realization caused a quick stock market drop.) To put it into perspective, a fed funds rate of 0.25% or 0.50% a few years from now still counts as quite accommodative, even if not the zero of today. The clustering of longer-term fed funds rate expectations remains around 2.5%. This implies, assuming the 2.0% inflation target is achieved and maintained, a real yield of 0.5%. This is below the multi-decade historical norm of about 1.0% for cash, but certainty an improvement on today’s miniscule yields (welcomed by savers), even if it takes time to get there.
The key question is when will the ‘tapering’ off of ongoing $120 bil./mo. treasury and mortgage bond purchases begin? ‘Talking about tapering’ has been the much-talked-about first step, followed by actually doing it. Hardly anyone thought it would happen at today’s meeting, but the timeline has certainly moved earlier after the strength in recent months. Only once tapering goes on for a while will rates likely start rising. Interestingly, based on CBOE fed funds futures, the probability of no change today had fallen to 93%, with the remaining 7% betting on a quarter-point increase. These odds remain consistent through December.
Most of the Fed’s metrics are showing improvement, as seen in many data releases:
Economic data for the week included stronger consumer inflation results, as well as higher job openings, and continued decline in the number of weekly jobless claims.
U.S. and European equity markets saw further gains, with accommodative policy and tempered longer-term inflation expectations swaying sentiment. Bonds earned positive returns as well, along with falling long-term interest rates. Commodities ticked higher, largely due to crude oil and natural gas prices.
On a Memorial-Day shortened week, economic data included strong results for manufacturing and services indexes. Employment numbers were mixed, as jobless claims improved, as did the employment situation report number, although the latter fell short of market expectations.
Global equity markets earned positive returns last week, with stronger economic data coupled with eased worries about the duration of continued government policy support. U.S. bonds gained slightly as interest rates pulled back after a lackluster jobs data. Commodities continued to gain ground, largely due to higher oil and natural gas prices last week.
Economic data for the week included largely unchanged Q1 GDP estimates, and a decline in durable goods orders. On the housing side, prices continue to show strong momentum, while sales fell due to increasingly tight inventories. Jobless claims continued to improve and point to labor market repair.
Global equity markets continued to benefit from strong economic rebound activity and consumer sentiment. Bonds also benefitted from a pullback in interest rates. Commodities were led by demand expectations for energy and metals.
Economic data for the week included declines but still-strong readings for key regional manufacturing indexes, and a pullback in home sales and starts, while jobless claims improved and the index of leading economic indicators continue to show strength.
U.S. equity markets declined last week, and underperformed gains in foreign markets along with improved sentiment for the future. Bonds were little changed, along with minimal change in the yield curve. Commodities were mixed, with most falling into the negative, including lower oil and metals prices.
U.S. stocks were down on net, with concerns over inflation mixing in with positive news about stronger economic data and vaccine-fueled reopenings. Early in the week, Treasury Secretary Yellen’s comments in favor of higher taxes and unions seemed to not please market sentiment, nor did Fed minutes discussing the idea of a ‘taper,’ while a pared-back infrastructure bill revision may have helped. The defensive group of utilities, health care, and consumer staples were the only sectors in the positive, in addition to a strong week for real estate. Energy, materials, and industrials fared worst, with declines well over a percent.
We’re reluctant to mention bitcoin, but the price has fallen over -50% from an April high of $65,000, before rebounding 40% within hours. The unfolding of this could have added to equity market volatility, and again shows the unique nature of cryptocurrency markets (a volatile store of value of there was one). Other than Elon Musk’s comments, the announcement about the Chinese government further restricting its use as a payment mechanism, as well as additional official reviews from other governments, have put a damper on the excitement as the outcomes become more bimodal.
Aside from ongoing fears of persistence in inflation, another market worry that appears to be taking up space is the growing possibility of corporate tax hikes. The 21% rate cut from 2017 is under threat, with consensus new rate of the 25-28% range (assuming that initial Democratic targets are lowered to garner broader support). While a net negative, it would still be far below the 35% top rate from pre-2017 period. And, as is the case of personal income tax rates, the top rate is just that—the average tax rate paid is far lower. Nevertheless, such legislation would trim earnings expectations for 2022 and beyond.
Foreign stocks gained mostly across the board, aside from the U.K., with Japan in the lead, followed by emerging markets. In Europe and other areas, slowing infection rates and an increased pace of reopenings continued to lead investor sentiment. This was evidenced by strong PMI figures in Europe and Japan, showing improved expansion in conditions. While emerging markets are still with large challenges from Covid infections and being far behind in vaccinations, compelling valuations a stronger cyclical tilt when conditions do improve remain in positive points in favor of non-U.S. equities.
U.S. bonds were little changed to slightly higher by a few basis points, as interest rates were steady across the yield curve. So, therefore, very little to report in terms of price change. A slightly weaker dollar helped developed market foreign bonds, which gained almost a half-percent for the week, while emerging market bonds fell back slightly.
Commodities lost ground on net, despite the normally positive influence of a weaker dollar. Declines in energy, agriculture, and industrial metals of up to several percent were offset by a rise in precious metals of nearly 2%. The price of crude oil declined by nearly -3% to around $63.50/barrel, as some supply concerns abated—mostly due to apparent progress on a renewed U.S.-Iran nuclear deal, which would bring more future oil supply to market.
Period ending 5/21/2021
1 Week (%)
YTD (%)
DJIA
-0.43
12.61
S&P 500
-0.39
11.29
NASDAQ
0.33
4.81
Russell 2000
-0.41
12.55
MSCI-EAFE
1.06
9.08
MSCI-EM
1.74
3.56
BBgBarc U.S. Aggregate
0.07
-2.63
U.S. Treasury Yields
3 Mo.
2 Yr.
5 Yr.
10 Yr.
30 Yr.
12/31/2020
0.09
0.13
0.36
0.93
1.65
5/14/2021
0.01
0.16
0.82
1.63
2.35
5/21/2021
0.01
0.17
0.84
1.63
2.33
Sources: LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.
The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.
FOR ADVISOR USE ONLY – NOT FOR DISTRIBUTION TO THE PUBLIC WITHOUT PRIOR APPROVAL FROM YOUR RESPECTIVE FIRM’S COMPLIANCE DEPARTMENT
Economic data for the week included a surprise higher for consumer inflation, with the strongest monthly report in decades, along with strong readings for producer price inflation and import prices. Industrial production also came in positively, while retail sales and consumer sentiment fell back a bit from a stronger prior months.
Equity markets experienced higher volatility last week as early fears of inflation were eventually replaced by optimism over the CDC’s looser recommendations about mask-wearing. Bonds fell back as higher long-term rates again pulled prices lower. Commodities were mixed, with gains in energy and declines in industrial metals and agriculture.
Economic data for the week included pullbacks but still historically-strong showings for manufacturing and services. While jobless claims improved, the employment situation report for April proved a disappointment.
U.S. equity markets fared positively last week, upon the heels of strong earnings reports and continued improvement in the global economy. Foreign stocks outperformed, with help from dollar weakness. Bonds also gained, as interest rates fell back further from recent highs; foreign debt benefited from dollar weakness as well. Commodities gained across the board with continued growth in demand and positive sentiment.
The Federal Reserve meeting last week resulted in no changes in policy, per expectations. Economic data included strong advance GDP results for Q1, as anticipated; and durable goods orders, housing prices, and consumer confidence all experienced growth.
U.S. equity markets were mixed to lower for the week, outperforming foreign stocks that lost ground in line with a stronger dollar. Bonds fell back as interest rates ticked higher. Commodities gained across the board along with stronger goods demand coupled with some supply concerns.
The Federal Reserve Open Market Committee made no changes in monetary policy today, keeping the target short-term interest rate at 0.00-0.25%. Nor was there any change in the pace and magnitude of their treasury and agency mortgage-backed security purchase program (‘quantitative easing’). Today’s outcome was predicted in CME futures markets at a 97% probability, although the chances for this same policy fell a bit to 90% by year-end, with a slim chance of a quarter-percent move higher by then.
Only a few words changed in the formal statement compared to March’s narrative. It acknowledged the degree of economic improvement in recent months, as fiscal policy, reopening, and vaccinations continue to be key drivers. Higher inflation was noted as reflecting ‘transitory factors,’ and the term ‘considerable’ when referring to risks was removed.
Economy: Following one of the weakest calendar years for GDP growth since the Great Depression, 2021 is estimated to experience growth at the strongest pace since the early 1980s. We may see growth at an above-average rate in 2022 as well, before it likely settles back into a longer-term secular pattern. The broad and sharp growth recovery hasn’t been surprising, and such a rapid rebound would typically push the Fed toward a faster path to normalcy. In this case, the Fed appears to be as sensitive to ‘micro’ effects as macro—including labor impacts on various populations.
Inflation: Based on the March CPI release, inflation has begun to pick up (year-over-year 2.6% headline, 1.6% core), but not yet to a sustained elevated level. Basing a 12-month result on a low March 2020 starting point accounted for some of this, while generally increasing economic activity, rising commodity prices, sporadic supply shortages, and delivery bottlenecks have also contributed. One of the loudest current debates in the economic and market community is how much inflation we’ll end up seeing, and for how long. A rise in short-term inflation has been welcomed by the Fed as it is intended to make up for the disinflationary shortfall experienced prior to the pandemic (with inflation level running well under the 2% target). Consumer inflation expectations have ticked up, but these have increasingly diverged with actual inflation readings in recent years. But one gets the impression the Fed is far happier to see consumers expecting CPI run at 3.5% than at 1.0%, particularly if higher wage inflation coincides with stronger labor markets, especially for lower-wage workers.
Spending to offset the pandemic’s economic damage ($5 tril. so far, almost 25% of U.S. GDP) has raised deficit and debt levels not seen since World War II. This, and the Fed’s seeming inflation tolerance, has raised worries over potentially higher long-term inflation, such as seen in the 1970s. There isn’t a clear precedent to provide guidance, but sustained future high inflation (defined as over 5% or so), does not seem to be the base case of most economists. A variety of long-term structural forces are at play that could continue to serve to depress economic growth and the inflation that can accompany it. These include demographics (aging population, which lowers spending and keeps demand for safety/yield high), weaker worker bargaining power (decline of labor unions), and ongoing advancements in automation and digitalization (which tend to reduce costs).
Employment: Looking beyond the most severe impacts of the pandemic shutdowns starting last spring, the baseline for ‘normal’ appears to be what the labor market looked like just prior, in early 2020. Standard statistics such as the unemployment rate, nonfarm payrolls, job openings, and jobless claims, have all shown strong improvement over the past few months. But we’re not back to ‘normal’ by any means. With maximum employment as a mandate of the Fed, they’re committed to eliminating labor slack, which would warrant keeping policy accommodative for longer (despite concerns over any counter-impacts on the ‘price stability’ mandate).
In the last few weeks/months, as the economy has begun to reopen and regain steam, there has been an increased divergence in the FOMC member estimates for future policy. This is seen through both the ‘dot plots’ in the Summary of Economic Projections release, but also in individual comments by Fed members in their speaking circuits. While a handful of officials see 2022 as the point rates will begin to rise, others are less optimistic, still anchored to a 2024 liftoff. These individual point estimates are notoriously subject to change, though, so should be taken with a grain of salt (as Chair Powell has said himself).
Conditions appear status quo for now, but financial markets are keenly sensitive to more durable changes in interest rate levels. This is especially due to their role as an input to risk asset valuation discounting models, and as a main starting point in the perpetual stocks vs. bonds attractiveness debate. Rates have remained low for years due to low overall real economic growth coupled with low inflation (and low inflation expectations), only to surprise by falling even lower due to the Covid recession. Although rates recovered sharply over the last few months, punishing bond prices, they still remain very low overall when viewed from a long-term chart.
The increasingly popular view is that the Fed’s window for action is tightening, as they walk a tightrope between keeping the economy stimulated as it recovers, but are able to exit easy policy smoothly before ‘too much’ inflation takes hold. They’re initially relying on communication for this, likely to be followed by a reduction in bond purchases, and then raising rates as a final step. The goal is to avoid surprises, but the risk in such micromanagement is that markets hang on every word, and one misquote or comment taken out of context can raise market volatility. The risks of some type of 2013-like ‘taper tantrum’ would have to be weighed against the eventual negatives of an economy running ‘too hot.’ Similarly, markets could react poorly before this if the Fed begins to sound ‘too’ optimistic, as this threatens the stretch of easy money coming to an early end faster. For now, broad cyclical recovery from 2020’s lost year is everyone’s primary goal.
FOR ADVISOR USE ONLY – NOT FOR DISTRIBUTION TO THE PUBLIC WITHOUT PRIOR APPROVAL FROM YOUR RESPECTIVE FIRM’S COMPLIANCE DEPARTMENT
Economic data for the week included a pullback in existing home sales, while new home sales, the index of leading economic indicators, and jobless claims all improved.
U.S. equity markets were mixed to lower last week, but outperformed developed markets, while emerging markets ended with a small gain. Bonds were little changed, in keeping with minimal changes in interest rates. Commodities continued a string of gains, with agricultural commodities leading the way, as oil fell.
Economic data for the week included several robust reports that demonstrate early economic recovery from the pandemic, with favorable ‘base effects’ from low points last March. These include strong readings for retail sales, housing starts, and several regional manufacturing indexes. Jobless claims have also improved.
Global stocks gained last week with continued strong economic data reports. Bonds also fared positively as interest rates ticked downward, with dovish central bank communications. Commodities earned positive returns in all groups, led by energy demand and a weaker dollar.
Economic data for the week included historical strength in ISM services, coupled with strength in job openings, and an especially strong increase in producer prices.
U.S. equity markets gained ground last week, outperforming foreign markets, which also showed gains to a lesser degree. Bonds also fared well with interest rates falling back a bit. Commodities were mixed, with agriculture and metals offsetting a pullback in energy prices.
LSA Connect 