It was quite an extraordinary week in financial markets and potentially a very consequential one. The S&P 500 closed on Thursday at a higher level than it was the day before the Federal Reserve first started raising interest rates in March 2022. In other words, the index has now officially erased more than a year of Fed-inflicted interest rate pain.
By the time the Fed meeting wrapped up on Wednesday, we had already received significant correspondence from the trenches of the war on inflation. When the Consumer Price Index (CPI) for May came out the day before, we learned that retail inflation has now fallen to below half of last year’s peak, but still remains well above what Federal Reserve officials would like to see.
Overall consumer prices increased just 0.1% from April to May, down from the prior month’s 0.4% increase for a solid drop in the annualized rate to 4.0%, down from 4.9%. The important Core CPI readings which strip out food and energy costs rose 0.4% month-over-month and 5.3% annualized, emphasizing the heavy impact of declining energy prices on the headline readings.
The year-ahead inflation expectations from consumers dropped to 3.3% which, interestingly, is exactly the average annual level of inflation in the US since 1914.
The Producer Price Index (PPI) measure of wholesale inflation experienced by manufacturers, which came out early on Wednesday morning shortly before the Fed interest rate announcement, showed an astonishing annualized rate of just 1.1%, well down from 2.9% thirty days earlier.
Markets had already been pretty confident of a long-awaited pause in interest rate hikes by the Fed the next day, but this inflation data sent the probability of no change soaring to 95% going into the Fed announcement on Wednesday afternoon.
What suddenly became important was the “Dot Plot” that the Fed releases quarterly with its interest rate decision. This shows the anticipated future trajectory of interest rates according to each member of the rate-setting committee (see EXPLAINER: FINANCIAL TERM OF THE WEEK, below).
And while the Fed did indeed deliver an announcement of no change in interest rates this time around (a unanimous call) ending 15 months of non-stop hikes, the dot plot showed that 12 of the 18 policymakers penciled in a 2023 year-end Fed Funds rate at or above 5.625% - versus the current rate of 5.125% that they just left unchanged.
So the forecasts implied that a majority of the committee members expect at least two additional quarter-point rate hikes (or one half-point increase) across the four remaining upcoming meetings of the year set for July, September, November and December. One committee member even foresees a full percentage point increase between now and New Year’s Eve.
Following the announcement of no change and the release of the dot plot, Fed Chair Jerome Powell, normally very affable and relaxed at press conferences, appeared rather edgy and irritable when faced with spikier-than-normal questions from financial journalists.
The dot plot initially shocked stock markets whose first reaction was take a big swan dive, but most markets then quickly reversed back upwards when Powell noticeably failed to take the opportunity when it was offered to him by a reporter to commit to a rate hike in July. In the end, most major stock indexes finished Wednesday basically unchanged from Tuesday’s close.
Bond yields (market-driven interest rates) predictably surged in reaction to the dot plot with shorter term rates reacting particularly violently. With shorter term yields moving higher faster than longer term ones, the benchmark inversion of the yield curve between the 2 year and the 10 year steepened further (see US TREASURY INTEREST RATE YIELD CURVE below), pushing towards record territory.
Once again however, stock market professionals seem to be saying that the Fed’s bark is worse than its bite and simply do not believe the dots (which frankly, do have a shaky track record of being ultimately correct). They are wondering aloud that if at least two more hikes really are still necessary, then why not implement one last week? When it was thrown at him, Powell’s answer to that question in the press conference was less than convincing. The sense hung in the air that a rather weak Fed was too afraid of causing a market surprise by raising rates when almost everyone expected them not to.
Stand by for a lot of chatter from Fed officials and presidents in the coming days and weeks as they try to roll out the central bank’s messaging and probably get into a verbal war with a once-again highly skeptical stock market which essentially showed its middle finger to the Fed on Thursday by moving considerably higher, including a new all-time high for Microsoft (MSFT).
In contrast, the Fed’s equivalent, the European Central Bank (ECB) showed much less concern for what the market thinks and raised its interest rate to 3.5%, the highest level in more than two decades. Unlike Powell, ECB President Christine Lagarde shut down debate and nuance and explicitly told everyone to expect even more hikes in the next meeting or even two as the central bank raised its expectations for upcoming Eurozone inflation. This followed recent interest rate hikes from central banks in the UK, Australia and Canada. The US Fed is beginning to look like a bit of an outlier.
Having said all that, not a single dot anywhere on the Fed’s chart indicated an interest rate cut in 2023. Realistic hopes of a swift Fed pivot to actually cutting rates are now in tatters. Powell even referred to the possibility of rate cuts as probably being “a couple of years out” in his press conference.
The deemed probability of interest rates being any lower at the end of the year is now 0%, quite the turnaround from the 100% certainty assigned to this outcome by the market just six weeks ago (see FEDWATCH INTEREST RATE PREDICTION TOOL below).
OTHER NEWS ..
Beyoncé caused inflation in Sweden .. Beyoncé, who launched her world tour in Sweden last month, is partially responsible for the rise of inflation in the country in May, according to Michael Grahn, Danske Bank’s chief economist.
Data published on Wednesday from Statistics Sweden showed that monthly inflation increased there by 0.3% from April to May. The hike was in large part due to a significant increase in prices paid for "a broad set of goods and services, for instance hotel and restaurant visits" and "recreational services" , which include concert tickets.
It seems that Beyoncé's two concerts in the Stockholm were partly to blame. Grahn estimated that two-thirds of that 0.3% inflation experienced in the country in May was tied to Beyoncé’s concerts there on May 10th and 11th. He did also say that"We expect this upside surprise to be reversed in June as prices on hotels and tickets reverse back to normal."
Another one bites the dust .. Crypto exchange CoinEx accepted a ban from operating in New York and to pay $1.8 million to settle state Attorney General Letitia James' lawsuit accusing the cryptocurrency exchange of operating illegally because it failed to register with the state and was unlawfully offering crypto tokens like AMP, LBRY, LUNA and Rally.
CoinEx (otherwise known as Vino Global) can no longer offer, sell or buy securities or commodities in New York and cannot make its platform available anywhere in the state. The settlement includes over a million dollars of refunds to thousands of investors plus a fine. The case was part of James’ enforcement efforts to rein in what she has called "shadowy" crypto companies.
Also, in a reminder of the apparently endless lingering risks of the lack of regulation in the space, South Korean-based crypto lenders Delio and Haru Invest - who each advertised double-digit yields for investors around the world who lent crypto on the platforms - both halted client withdrawals, which is usually a prelude to customers losing all of their deposits.
UNDER THE HOOD ..
The 4,300-4,330 price area in the S&P 500 index was identified as where stocks stalled last August before falling to new 52-week lows in October and also as the 50% retracement line of the selloff of 2022. The index blew through that level, closing on Thursday at 4425 and still remained above that zone even after a mild pullback on Friday.
It was notable that on Wednesday that while the S&P 500 and NASDAQ Large Cap universe recovered pretty much all the losses they suffered immediately on interest rate fears after the dot plot came out to end the day essentially flat, Small Cap stocks - which outnumber Large Caps by a wide margin - pointedly failed to recover at all, ending the day down over 1.0%. This was yet another example of two very different worlds operating completely independently of each other within the same stock market, but the headlines only focus on one of them.
This is the so-called “Mega-Cap mirage” which may be prematurely projecting the illusion of a new bull market, since it is Small Cap stocks - not their Large Cap cousins - that historically have led the charge from major market bottoms. and the relative performance of the Mid Cap and Small Cap stocks lagged that of Large Cap yet again last week.
As I have mentioned many times, none of the traditional signs of a market bottom (capitulation, conviction, and correlation) were measurably realized when the October 2022 lows were established and this continues to nag at technical analysis crowd.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
US stock and bond markets will be closed on Monday in observance of Juneteenth National Independence Day. There’ll be just a handful of earnings reports during the week as well as two days of semi-annual Congressional testimony to the Senate Banking Committee from Federal Reserve chairman Jerome Powell.
FedEx, Accenture, Car Max, FactSet and Darden Restaurants report this week.
There will be plenty of data out on the state of the US housing market, including the Housing Market Index, Residential Construction data and Existing Home Sales.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com
- Last week’s best performing US sector: Technology (two biggest holdings: Apple, Microsoft) - up 4.4% for the week.
- Last week’s worst performing US sector: Energy (two biggest holdings: Exxon Mobil, Chevron) - down 0.6% for the week.
- The proprietary Lowry's measure for US Market Buying Power is currently at 167 and rose by 9 points last week and that of US Market Selling Pressure is now at 127 and fell by 10 points over the course of the week.
- SPY, the S&P 500 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line with a technically over-bought RSI of 71**. SPY ended the week 8.0% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line with a technically over-bought RSI of 75**. QQQ ended the week 8.9% below its all-time high (11/19/2021).
** RSI (Relative Strength Index) above 70: technically over-bought; RSI below 30: technically over-sold
- VIX, the commonly-accepted measure of expected upcoming stock market risk and volatility (often referred to as the “fear index”), implied by S&P 500 index option trading, ended the week 0.3 points lower at 13.5. It remains below its 50-day and 90-day moving averages and below its long term trend line.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.69%
(one week ago: 6.71%, one month ago: 6.31%, one year ago: 5.78%)
Data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
US INVESTOR SENTIMENT (outlook for the upcoming 6 months) ..
↑Bullish: 45% (45% a week ago)
↔ Neutral: 32% (31% a week ago)
↓Bearish: 23% (24% a week ago)
Net Bull-Bear spread: ↑Bullish by 22 (Bullish by 21 a week ago)
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
Data courtesy of: American Association of Individual Investors (AAII).
FEAR & GREED INDEX ..
“Be fearful when others are greedy and be greedy when others are fearful.” Warren Buffet.
The Fear & Greed Index from CNN Business can be used as an attempt to gauge whether or not stocks are fairly priced and to determine the mood of the market.
It is a compilation of seven different indicators that measure some aspect of stock market behavior. They are market momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility and safe haven demand.
Extreme Fear readings can lead to potential opportunities as investors may have driven prices “too low” from a possibly excessive risk-off negative sentiment.
Extreme Greed readings can be associated with a sense of “FOMO” and investors chasing rallies in an excessively risk-on environment, possibly leaving the market vulnerable to a sharp downward correction at some point.
Data courtesy of CNN Business.
US TREASURY INTEREST RATE YIELD CURVE ..
The interest rate yield curve remains “inverted” (i.e. most shorter term interest rates are higher than longer term ones) with the highest rate (5.38%) being paid currently for the 4-month duration and the lowest rate (3.77%) for the 10-year.
The closely-watched and most commonly-used comparative measure of the spread between the 2-year and the 10-year last week rose significantly from 0.79% to 0.93%, indicating an overall steepening of the inversion of the curve during the last five days.
Historically, an inverted yield curve has been regarded as a leading indicator of an impending recession, with shorter term risk deemed to be unusually higher than longer term. The steeper the inversion, the greater the deemed risk of recession.
The curve has been inverted since July 2022 based on the 2 year vs. 10 year spread.
Data courtesy of ustreasuryyieldcurve.com as of Friday.
FEDWATCH INTEREST RATE PREDICTION TOOL ..
Where will interest rates (Fed Funds rate, currently 5.125%) be at the end of 2023?
↓ Lower than now .. 0% probability
(one week ago: 0%, one month ago: 16%)
↔ Unchanged from now .. 24% probability
(one week ago: 30%, one month ago: 61%)
↑ Higher than now .. 76% probability
(one week ago: 70%, one month ago: 23%)
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.125%) on July 26th after its next meeting?
↓ 0.25% cut .. 0% probability
(one week ago: 0%, one month ago: 23%)
↔ No change .. 26% probability
(one week ago: 30%, one month ago: 61%)
↑ 0.25% increase .. 74% probability
(one week ago: 53%, one month ago: 16%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
ARTICLE OF THE WEEK ..
When it comes to investing, doing nothing is harder than it sounds.
EXPLAINER: FINANCIAL TERM OF THE WEEK ..
A weekly feature using information found on Investopedia to try to help explain Wall Street gobbledygook (may be edited at times for clarity).
Dot plots are well known as the method that the Fed uses to convey its benchmark federal funds interest rate outlook at certain Federal Open Market Committee (FOMC) meetings. FOMC members place dots on the dot plot denoting their projections for future interest rates in subsequent years and in the longer run.
The FOMC dot plot is one of the more famous dot plots, where each dot marks where a respective FOMC member expects the federal funds rate to be at the end of a particular period.
Usually, the overall FOMC outlook for interest rates in any given year is reported as the median of the dots that show up on the dot plot. The Fed's dot plot projections are closely watched by investors and economists for indications of the future trajectory of interest rates.
Keep in mind, when you're looking at the FOMC chart, that each dot represents a member’s view of the range where rates should be at that time. Their dot is in the center of the range. In other words, the dots shouldn't be taken to represent that a member is targeting that specific number. Importantly, it is not known which dot belongs to which FOMC member.
It’s also important to remember that the Fed is largely data-driven, and so it constantly adjusts its expectations and rates based on economic trends and global events. In the event of major developments, such as a terrorist attack, a severe economic downturn, or a sharp jump in inflation, the most recent dot chart may no longer represent members' projections.
As a result, the longer-term projections on the dot plot carry less weight than those that are closer to the present. Changes among Fed leadership—as terms expire, people resign, and others step up to fill the vacated positions—add to the potential for long-term policy shifts.
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