The Fed will continue to dominate the market in the week to come after the liquidation

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Traders on the floor of the New York Stock Exchange.

Source: NYSE

The Federal Reserve’s signal that it is looking to move away from part of its ease policy is expected to be a dominant trading theme in the coming week and possibly for the rest of the summer.

Investors repositioned themselves in financial markets last week after Fed Chairman Jerome Powell said on Wednesday the central bank was considering cutting its purchases of Treasuries and mortgage securities. This is important because when the Fed does finally act, it would be the first serious reversal of the easy policies it put in place to add liquidity to the markets when the economy closed last year due to the Covid crisis. .

Purchases, which stand at $ 120 billion per month, would be gradually reduced once the Fed decides to slow down and end bond buying or quantitative easing. This could then open the door to interest rate hikes, which the Fed now plans to have in 2023.

The Federal Reserve sent ripples to financial markets after its Wednesday meeting. The dollar surged, stocks fell, and bond yields moved to imply higher short-term interest rates going forward.

“I think the market is still digesting the Fed meeting,” said Ed Keon, chief investment strategist at QMA. Stocks were trading sharply lower on Friday, following weakness on Wednesday and Thursday. Yields fell on longer-dated bonds, such as the 10-year benchmark, but increased on shorter 2- and 5-year bonds.

The spreads between these shorter-dated bonds and the 10- and 30-year bond yields have narrowed considerably in a so-called flattening trade. It is common when interest rates rise. Higher short rates reflect expected increases in the fed funds rate, while longer-term yields fall, as it has always been thought that a Fed tightening slows the economy.

The Fed also provided new economic forecasts, including an interest rate chart that shows it plans to hike its fed funds rate twice in 2023, after its previous forecast did not include any increases.

Fed speakers will receive a lot of attention over the coming week. Powell speaks Tuesday before the House coronavirus crisis subcommittee on the Fed’s policy response and the economy. His remarks could be a culmination of what appears to be a slow but volatile first week of summer for markets.

A number of other Fed officials spoke, including New York Fed Chairman John Williams on Monday and San Francisco Fed Chairman Mary Daly and Fed Chairman of Cleveland, Loretta Mester, both Tuesday. Other Fed speakers include Atlanta Fed Chairman Raphael Bostic and St. Louis Fed Chairman James Bullard.

“Getting more color from others will definitely be the key,” said Peter Boockvar, chief investment strategist at Bleakley Global Advisors. “I’m certainly very interested in what Powell has to say. They’re all going to give us now the fine print of what was in the statement and what Powell said” at the end of the Fed meeting in June.

Data on personal consumption spending is expected to generate a lot of interest next Friday, as it includes the PCE inflation index, which the Fed closely watched. The Fed has insisted that the high inflation figures are only temporary and should subside next year.

Boockvar said the inflation data should reflect the same price spike that appeared in the consumer price index for May, up 5% year-over-year.

“It’s going to show pretty robust increases month over month,” Boockvar said. He said inflation data will be the most important for the markets.

“That’s the topic of the rest of the year – inflation, inflation, inflation and how the Federal Reserve adjusts to it,” he said. “In this inflation debate, it’s not just an American affair, it’s a global affair.”

While the Fed has now forecast two interest rate hikes for 2023, the market is more skeptical about inflation. Depending on the futures markets, investors believe there could be one or more rate hikes next year and at least four in total before the end of 2023.

The Fed is forecasting PCE inflation of 3.4% for this year, up one point from its March forecast, but still expects a moderate pace of 2.1% next year.

Housing data will also be of great interest to markets, after the Fed’s small step towards tightening sparked mortgage rates soaring.

The 30-year fixed loan rate jumped to 3.25% Thursday, the highest in months, according to Mortgage News Daily. The Fed is currently buying about $ 40 billion a month in mortgage-backed securities, and that would slow down with Treasury purchases.

Existing home sales are released on Tuesday and new home sales are posted on Wednesday.

Value versus growth

Keon said the market is collapsing but is taking the Fed’s change into account. He said he had overweight stocks in his portfolios. “We like this position with earnings likely to grow 40% this year with rates remaining pretty low. It’s a good environment for equities,” he said.

As the market traded lower last week, technology and some growth names held their own, and it was the only major sector to be up for the week on Friday morning. The worst performing sectors were in the value space – linked to commodities or part of cyclical reopening trade.

Materials were down more than 5% for the week on Friday morning, and financials were down more than 6% as a flattening of the yield curve could hurt bank profits.

“We’ve had a really good move for the value stocks and for the reopening coins. They’ve been doing really well for about six months,” Keon said. “There’s nothing in the market that goes on forever. It’s probably a bit of a counter-rotation. Whether it’s the start of a major change or a slight rebound. [for tech], it’s hard to say and the rates are going to be decisive. “

Keon said if the closely watched 10-year yield rises to 2% from its current 1.5%, it would be positive for value stocks. But if it stays anchored around 1.5%, technology could continue to do well.

The 10-year yield, which is the Treasury benchmark, fluctuated significantly last week. After starting the week at around 1.45%, it rose right after the Fed meeting to 1.59%, but then fell back to around 1.47% on Friday morning.

“I guess the idea is that at the press conference, Powell made it clear that he had no intention of raising rates until 2023,” Keon said. “Until 2023, you’ll get the boom we’re in right now, and you’ll get pretty strong growth in 2022. By 2023 the economy is going to slow down and will the Fed hike rates in a slowing economy? Probably not. “

Keon said this will keep a cap on the size of the Fed’s rate hikes. He said the Fed was unlikely to increase until 2023, unless there was a surprise on the rise in inflation.

“The market believes that the Fed will not hike rates until 2023, barring an unexpected surprise for inflation, and that it will not hike rates as much in 2023 as it would risk a recession,” he said. .

Julian Emanuel, head of equity and derivatives strategy at BTIG, said the Fed has now injected a new level of volatility into the markets. He expects investors to be on the alert now as the Fed meeting approaches in late July and again as the Fed travels to Jackson Hole, Wyoming, in late August for its annual symposium.

Many economists expect Jackson Hole to be the forum where the Fed will post details of the reduction program. Once the Fed announces that it is going to cut, it should then wait a few months before slowly reducing purchases over several months. The end of the easing program is important because it would then open the door to a possible rate hike, depending on the strength of the economy.

“The narrative here is that the markets are likely to continue to move back and forth when it comes to their take on the Fed’s assessment of whether the transient is correct or not,” Emanuel said. “Transient” is how the Fed describes its view that the spike in inflation will be short-lived.

Over the past week, some of the inflationary pressure in the market has dissipated with a sell-off in the commodities complex. The Fed’s political rhetoric helped spur the dollar to rise, which was part of the cause of the selloff. But the first catalyst was a move by China to cool hot commodity markets. Reuters reported that a Chinese government agency was planning to release reserves of aluminum, copper and zinc.

As of Friday morning, copper was down more than 8.3% on the week.

Calendar for the upcoming week (ET)

Monday

9:30 a.m. St. Louis Fed Chairman James Bullard

3:00 p.m. New York Fed Chairman John Williams

Tuesday

Earnings: Korn Ferry

10 a.m. Sales of existing homes

10:30 a.m. Loretta Mester, President of the Cleveland Fed

1:00 p.m. San Francisco Fed President Mary Daly

2 p.m. Fed Chairman Jerome Powell speaks to Congress on pandemic programs and economics

Wednesday

Earnings: IHS Markit, Winnebago, KB Home, Steelcase

8:30 am Q1 Current account

9:10 a.m. Fed Governor Michelle Bowman

9:45 a.m. Manufacturing PMI

9.45 a.m. PMI Services

10 a.m. New home sales

11:00 a.m. Raphael Bostic, President of the Atlanta Fed

4:30 p.m. Boston Fed Chairman Eric Rosengren

Thursday

Earnings: Accenture, Darden, Rite Aid, Nike, FedEx, Blackberry

8:30 am Unemployment claims

8:30 am Durable goods

8:30 a.m. Q1 real GDP (third reading)

8:30 am Advanced economic indicators

9:30 a.m. Bostic of the Atlanta Fed

11:00 a.m. New York Fed Williams

1 p.m. Saint-Louis Fed Bullard

Friday

Earnings: CarMax, Paychex

8:30 am Personal income / expenses / PCE inflation

10 a.m. Consumer sentiment

11:35 am Mester of the Cleveland Fed

1 p.m. Boston Fed Rosengren

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