The major US indexes ended higher this week continuing their rally, with the S&P 500 posting its fifth consecutive weekly gain, marking its longest stretch of daily gains since November 2021 and its best weekly performance since the end of March. All sectors, except for energy, ended the week higher, with small caps only seeing slight gains compared to large gains in the prior two weeks. The three major U.S. indexes posted weekly gains between 1.25% and 3.25%, and the S&P 500 and the NASDAQ rose to their highest levels in 13 months. Despite the Fed’s policy announcement, investors noted that fixed income markets were calm overall, with limited issuance and credit spread movements in most sectors, probably due to the upcoming holiday weekend. Markets are scheduled to close on Monday in observance of the Juneteenth holiday.
The Fed kept interest rates unchanged last week, as inflation is on a downward path and the economy is showing signs of softening. Most economists don't think this is the end of rate hikes, but instead offers an opportunity for the Fed to evaluate inflation and economic conditions before making further moves. We expect the Fed to continue its hawkishness to bring inflation back toward its target, to ensure financial conditions don't reignite inflation pressures. The stock market rally was aided by the outlook for a less-aggressive Fed. We don't think the market has to give back all the recent gains, but we do believe investors should expect some volatility as we progress. Treasuries were mostly weaker with the curve flattening, as the 2-year to 10-year spread moved back to its most inverted level since before the banking mini crisis in early March. The dollar index was notably weaker overall. The Federal Reserve unanimously voted to leave the Fed funds target rate unchanged on Wednesday, keeping it at 5.00% to 5.25%. Despite this pause in rate hikes, we believe Fed is determined on bringing inflation down to its 2% target. Going forward, we expect that Fed policy may remain tighter for longer, while a restrictive monetary policy continues to weigh on economic growth. The Federal Open Market Committee’s official statement was largely unchanged from the May meeting. This pause according to analysts gives the data-dependent Fed more time to analyze the upcoming economic and employment data. The biggest surprise of the meeting was the release of the Summary of Economic Projections specifically the “dot plot.” The median dot for the Fed funds target rate rose to 5.6% by the end of 2023; this is an increase of 50 basis points (bps) over the previous projection released in March. This implies that two more 25-bp hikes are likely to occur this year. In his press conference, Fed Chairman Jerome Powell made it clear that the bias at the Fed remains heavily tilted toward fighting inflation, even if that comes at the expense of weaker economic growth through tighter credit conditions. We expect that the Fed will keep rates higher for longer and won’t cut rates anytime soon. In our view, we believe there will be another 25-bp rate hike at the Fed’s July meeting. Some economists believe that the Fed has rates high enough to meaningfully fight inflation and can hold them there until inflation starts moving closer to the Fed’s 2% target. On Tuesday, the Labor Department announced that Consumer Price Index (CPI) rose by 0.1% month over month and had increased at a year-over-year pace of 4.0%—still double the Federal Reserve’s target, but down from the prior month’s 4.9% and the slowest pace since March 2021. On Thursday, the Labor Department revealed that producer prices had declined 0.3% in May, marking four declines over the past six months. Analyzing the data, energy prices declined by 3.6% month over month in May, bringing the annual energy inflation rate to –11.7%. The decline was due primarily to a sharp fall in gasoline prices. Utilities prices also decline due to a sharp drop in natural gas prices. Food prices increased slightly by 0.2% month over month, while there was a 13.8% month over month drop in egg prices as distortions from external factors. Core CPI (excluding food and energy) rose by 0.4% MoM again in May and by 5.3% YoY, after rising by 5.5% YoY in April. We expect the price of goods to continue to moderate throughout 2023 as consumer demand weakens and supply issues ease. Retail sales were stronger than expected in May, signaling that the consumer remains resilient despite depleted pandemic savings, high inflation, and high interest rates. Retail sales increased by 0.3% month over month in May. The strength of retail sales data illustrates that economic growth won’t slow until the consumer stops spending. In euro terms, the pan-European STOXX Europe 600 Index rallied 1.47% as the U.S. Federal Reserve refrained from raising rates this month. Hopes that China might proceed to stimulus measures appeared to lift stocks. Major equity indexes also advanced. Germany’s DAX gained 2.56%, France’s CAC 40 Index tacked on 2.43%, and Italy’s FTSE MIB climbed 2.58%. The 10-year German government bond yield climbed above 2.5% after the European Central Bank raised interest rates and signaled more tightening was likely. Swiss and French yields also headed higher. The ECB raised its key deposit rate by a quarter-point to 3.5%—the highest level in 22 years. ECB President Christine Lagarde said after the meeting that policymakers “still have ground to cover” and that they would probably tighten borrowing costs again in July, unless there was a “material change in the baseline outlook.” The ECB also raised its forecasts for headline and core inflation across the three-year time horizon. The central bank lowered its estimates for economic growth. In order to shrink its balance sheet, the ECB confirmed that it would stop reinvesting the proceeds of its asset purchase program from July. Japan’s stock markets performed strong gains for the week, with the Nikkei 225 Index rising 4.5% and the broader TOPIX Index finishing 3.4% higher. The markets’ reached their highest levels in over three decades supported by the Bank of Japan’s decision to leave its loose monetary policy unchanged; it was widely anticipated. Stronger-than-expected Japanese economic data boosted sentiment. Equity and bond markets will experience elevated volatility until there’s a meaningful and consistent decrease in inflation. We remain defensive in our positioning, and we’d look for opportunities to upgrade portfolios during market weakness. Within equities, we continue to favor U.S. Large Cap exposure, since China’s policies continue to weigh on manufacturing and growth. We have been more constructive on Developed International equities, as the energy recession wasn’t as severe as anticipated. In the United States, large-cap equities provide an attractive blend of quality, yield and growth at a reasonable value. For fixed income, we remain defensive in our credit positioning and higher in credit quality. We expect that credit spreads will leak wider to account for slowing growth and recession risks. We think these are conditions long-term investors as they can buy in dips and proactively rebalance their portfolios.