Weekly market update - 21st of June 2021
Written and accurate as at: Jun 21, 2021 Current Stats & Facts
The US Federal Reserve hit back last week against the view that they are complacent on inflation. There was no explicit message on tapering out of the latest meeting of the Fed’s monetary policy arm, the Federal Open Market Committee. But the “dot plot” of the committee’s rate expectations — and the language in an accompanying statement — were clearly more hawkish than the market expected. The US yields curve flattened in response. Two and five-year yields rose, while 10-year yields were flat and 30-year yields fell. This also triggered a rally in the US dollar. In the equity market, we saw a sharp rotation out of cyclicals and commodities and into technology. Overall the S&P/ASX 300 was up 0.7%, and the S&P 500 was down 1.9%.
Economics and policy
The key point in the Fed release was a shift in the FOMC “dot points” — a chart that outlines interest rate expectations of the 12 FOMC members. The median view of the committee shifted from zero to two expected hikes by the end of 2023. The three senior committee members are all apparently expecting at least one hike. The median inflation forecast for 2021 shifted up markedly from about 2.2% to about 3%. This is still considered transitory. Fed chair Jerome Powell noted the recent retracement in the lumber price, for example. As a result, expectations for 2023 CPI remained constant at about 2.1%.
This suggests average inflation will return to where the Fed wants to see it earlier than they previously thought, which explains a shift in the first expected rate hike. Nevertheless, we should consider inflation expectations in the context that the Fed has been as inaccurate as anyone else when forecasting the path of rates based on its historical predictions versus actual outcome.
There was also a change in the release's wording, which suggested the tapering decision was no longer more than six months away. The Fed’s hawkish tone gave the market more confidence that inflation will be contained. Break-even inflation expectations fell, which prompted flattening in the Treasury yield curve.
Yield curve shift
The shift in the yield curve was material, which probably reflects the strength of the consensus position towards inflationary trades. The debate now is whether this is just an adjustment in signalling or a more significant pivot in the Fed’s stance. Statements this week will be important to watch. The Fed is unlikely to want any further flattening in the yield curve. So we would not be surprised to see the messaging shift subtlety back to promoting growth.
The US dollar rose along with the short end of the yield curve, which weighed on commodity prices, particularly in crowded trades such as copper, which fell 8.3%. Gold was off 5.8%.
Covid and vaccines outlook
We continue to monitor developments around the Delta variant of Covid, given its potential for larger outbreaks and a higher vaccination threshold for herd immunity. The UK is the bellwether in this regard. So far, a rise in cases has not fed through to higher hospitalisations. This is potentially due to Delta being more benign than the original strain. The level of vaccinations may also be playing a role.
The latest Australian outbreak needs to be monitored, given the slow rollout of vaccines. The risk of further restrictions has risen. Domestic re-opening trades are struggling to perform in this context. There is a clear divergence from global re-opening exposures. But we are mindful that sentiment can swing quickly in this regard.
Markets
It is important to emphasise that the Fed’s hawkish bent does not guarantee markets have peaked for this cycle. First, the broad policy environment remains supportive. We are still looking at two years of near-zero rates, and monetary policy has a large lag. Fiscal policy also remains high stimulative. Second, if history is a guide, the first hike in a cycle normally prompts a market correction. However, the actual peak has tended to occur after rates have risen several times. Overall, equity markets seem to have digested the Fed’s shift quite comfortably thus far.
The divergence between oil and copper is interesting. Copper is off 11.1% for the month, while Brent crude is up 6%. Again, this probably reflects consensus positioning in recent months. The Australian market was dominated last week by thematic rotation. Technology (+12.4%) and Health care (+6.2%) led, while resources dragged down Materials (-4.7%). Banks (+2.2%) held up reasonably well, in contrast to overseas markets. There may be some near-term vulnerability here.
Gold miners led the underperformers. Northern Star (NST, -13.9%) was the worst in the ASX 100, followed closely by Newcrest (NCM, -8.4%) and Evolution (EVN, -8.1%).
Copper miner Oz Minerals (OZL, -12.2%) also lagged.
Contractor Downer (DOW, -7.2%) also fell, following a broker note highlighting wage pressure in the contracting space. Regardless, DOW continued with its stock buy-back, which suggests this is not the issue of some fear.
ResMed (RMD, +12.5%) was the best in the ASX 100. In this case, the growth rotation was augmented by news of a product recall from a competitor.
Afterpay (APT, +10.5%) is the most leveraged to the growth trade at the moment. Xero (XRO, +6.1%) also benefited.
A stronger US dollar is beneficial for Ansell (ANN, +9.4%), Cochlear (COH, +4.8%), James Hardie (JHX, +3.6%) and RMD, among others.
Finally, Coles (COL, -1.9%) held a strategy day which flagged that Capex will need to rise to compensate for under-investment in recent years. Capex will rise from 2% to more than 3% of sales per year. This raises questions for the supermarket sector as rising capital intensity may dilute returns. COL also signalled that they see the trend to more neighbourhood style unwinding, although we doubt this is material in the current Covid environment.