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Weekly Market Update for June 18, 2021

by JM Hanley

Investors spent the first half of the week awaiting the outcome of the Federal Reserve meeting Wednesday. When the meeting ended, there were two surprises. The Fed was more “hawkish,” or aggressive about raising interest rates, than expected. The second was the market’s reaction. Treasury yields normally rise when faced with higher interest rates. Instead, the curve “flattened,” as near-term Treasury yields rose and those for longer-dated bonds fell. This is consistent with higher-than-expected interest rates in the short term, and lower inflation in the longer term. The SP 500 ended the week down nearly 2%, while the Nasdaq was down 0.3%.

The Fed’s meeting was hawkish on two fronts. The Fed now anticipates it will raise interest rates twice in 2023. Previously, it hadn’t anticipated any increase until 2024. The Fed also broached the subject of when it would slow its bond-purchasing program (which currently totals about $120 billion per month). This helped keep corporate debt markets liquid during the depths of the pandemic.

The faster pace of rates hikes was more surprising because it followed weeks of sluggish economic data (like jobs reports). Indeed, the Fed’s forecasts of future economic growth were revised up just slightly. Instead, their commentary emphasized the rapid improvement in the covid outlook. Reduced economic risk from the pandemic likely explains much of the newly aggressive stance.

The week’s rate news was all the more important because it was the first hike previewed under the Fed’s new interest-rate policy, average inflation targeting. Many thought this shift would lead the Fed to let inflation run hot for a while to make up for years of sluggish numbers. That doesn’t appear to be (entirely) the case. This explains why long-dated Treasury bonds now imply lower inflation and lower interest rates will persist in the future.

Other economic data this week suggested the economy is recovering more slowly than expected. Initial jobless claims and retail sales came in lower than anticipated. So did two Northeastern manufacturing indices. The high cost of building materials weighed down new housing starts.

The weak data and Fed’s new stance prompted investors to reassess “reopening” stocks. Markets had anticipated that even lackluster businesses would benefit from a booming economy, plenty of government stimulus, and a steady supply of cheap money. With the first and the last now in question, funds shifted to sectors that do well even in a slower-growth economy. Technology and healthcare stocks did well. Materials, energy, and industrials trailed the market.

Highlights on next week’s economic calendar include existing home sales on Tuesday and new home sales on Wednesday. Friday will bring personal income, personal spending, and consumer confidence updates.

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