The Market Pulse will return on January 3, 2022. Happy Holidays and have a great new year.
Stocks in the U.S. had a strong week, with the S&P 500 finishing the week at a record high for the 67thtime this year. The 10-year U.S. Treasury yield also rose 14 basis points to 1.48% and the yield curve steepened, though it still remains near the lowest levels of 2021. All of this came despite the fact that inflation came in at the highest year-over-year level since 1982. The reason markets rallied in the face of this was that inflation met consensus forecasts, but didn’t exceed them. This led to investors paring back the amount of Federal Reserve (Fed) rate hikes priced into the markets. Our read of this action is that investors believe the Fed is too hawkish, meaning that they expect a policy error to derail the economic recovery.
As we have written about, our view is that markets are pricing in too hawkish of a Fed, and we think this will normalize over time. Ultimately, our view is that the Fed will be patient and hike rates slower than market expectations. We are led to this view in part due to the 2/10-year U.S. Treasury yield curve. The yield curve spread currently sits at 83 basis points, which puts the Fed in a tough position. The interest rate-setting FOMC would not want to hike the yield curve into inversion, which is something that happened in 2019, after the 2015-2018 tightening cycle. Absent a marked rise in longer yields, the market’s expectations for future Fed rate hikes would significantly raise the threat of another inversion. Given the stock market declines at the tail end of the last tightening cycle, we think the Fed will ultimately be patient to avoid a repeat of 2018.
A look back
- Global stocks had a strong week with the MSCI ACWI gaining 3%, driven by equities in the U.S. The S&P 500 had its best weekly showing since February.
- The Consumer Price Index came in at 6.8% on a year-over-year basis, meeting consensus estimates. This was the highest headline reading since 1982.
- Olaf Scholz officially succeeded Angela Merkel as Chancellor of Germany, ending her 16-year tenure. Chancellor Scholz’s Social Democrats are part of a three-way coalition that includes the Green Party and Free Democrat Party.
A look ahead
- Market participants will be keenly focused on this week’s meeting of the Federal Open Market Committee (FOMC) and Chair Powell’s press conference, looking for hints about policy changes.
- G-7 finance ministers are set to meet virtually on Monday to discuss recent inflationary pressures.
- Economic releases: NFIB Small Business Optimism, Producer Price Index, MBA Mortgage Applications, Retail Sales, Markit Manufacturing & Services, Housing Starts, Building Permits, Industrial Production, and FOMC rate decision.
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