Unchanged Fed; Markets Exit Dead Zone

March 25, 2021

Market Update. Equity markets were marginally lower last week as the Federal Reserve was unchanged and stuck to the script. However, short term, longer-term interest rates continued to rise. The S&P 500 dropped 0.8%, with year-to-date leaders, energy and banks leading the declines. Telecom and consumer staples (defensive low-beta sectors) managed small gains.leaving dead zone; Fed unchanged

Much to the dismay of the financial press ongoing “boom cycle” talk, the near-term economic data has recently missed expectation as the Citi Economic Surprise index continues its normal dead zone, a late-Q1 decline. So far both the bond markets and overall stock markets have largely dismissed weaker February numbers.

Federal Reserve policy unchanged

As expected, the Federal Reserve left policy unchanged last week. The Fed reiterated that the range for the fed funds rate will be maintained “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time”. Moreover, the QE program will be maintained “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.” In plain English, despite strong economic momentum and another heavy wave of fiscal stimulus, the Fed is unchanged and comfortably sitting still.

The Federal Reserve announced that it will let the temporary change to the supplementary leverage ratio (SLR) for banks (which was brought in during May 2020) to expire at the end of March. This was a depth-of-the-pandemic measure to shore up lending capacity through the pandemic—Treasuries and bank stocks sold off early Friday but clawed back part of the moves by later in the day.  Speculation on this policy has led to much of the Treasury market/”Collateral damage and volatility” since the end of February. With this news now in the market, and us exiting the “dead zone of Q1”, investors focus should pivot to earnings, stock buybacks, and the fiscal stimulus for the next 5–8 weeks.

Bonds and inflation

Long-term bond yields continued to move higher last week, with the 10-year Treasury yield topping 1.7% for the first time since January 2020. So, 10-year Treasuries moved up almost 120 bps from the pandemic low set in July and 80 bps on the year.  However, the inflation component of yields looks to be peaking along with oil, copper, lumber, containerboard and many of commodities that lead inflation readings and fears.

Year to date, rate-sensitive sectors have lagged, while high-growth technology has struggled with a higher discount rate. Financials (primarily old school regional banks), have been leaders on a steeper yield curve, with banks up 24% in the U.S.

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