Market Minutes: Dotting and plotting

What a week we had last week and what a week lies ahead – we know all about the former with another surge in US inflation – the coming few days is all about the two-day Fed meeting and the decision, the wording of the post meeting statement and new forecasts – especially for US inflation and growth.

Markets Friday were flattened by the worse than expected consumer price rise of 8.6% in the year to May.

That saw the Dow shed 880 points, or 2.73%, to close at 31,392.79 on Friday. The S&P 500 lost 2.91% to settle at 3,900.86. The Nasdaq Composite sank 3.52% to 11,340.02.

The S&P 500 fell 5.1%, while the tech-heavy Nasdaq shed 5.6%. The Dow lost 4.6% last week.

At the Fed’s May meeting, chair Jay Powell had set the stage for half-point rises in both June and July, but some questions remained about whether the Fed would continue at that pace at its meeting in September.

Stocks ended May with a rally off the 2022 lows on the speculation that maybe the worst of the inflation is over, but Friday’s CPI report dashed those hopes. The S&P 500 is back down nearly 19% from its record and sits roughly even with its May closing low for the year.

The Fed meeting will dominate but there will also be considerable attention on the Bank of England meeting as well as a meeting of the Bank of Japan.

US retail sales data this week will also be watched closely to see how consumption is holding up and the face of rising energy (especially petrol) prices.

The post-meeting data early Thursday morning will include the new version of the ‘dot plot’ where Open Market Committee members update their (anonymous) projections of interest rate movements, new economic forecasts and the post-meeting media conference of chair, Jay Powell.

And all that makes it one of the most important meetings for quite a while by the world’s leading central bank.

One thing is certain – the Fed will lift rates by 0.50% (0.75% is being tipped in some circles just to really frighten everyone), lift inflation forecasts, slash growth forecasts and project inflation to remain higher for longer.

And the dot plot will reflect that new reality.

Last week we got a nasty reminder of the strength of inflation – on Friday the higher-than-expected rise in May; the move by the European Central Bank the day before to join the rate rise stream of other central banks, and the Reserve Bank’s 0.50% rate increase here in Australia.

The World Bank and the OECD last week lowered their growth forecasts and oil topped $US120 a barrel, again, adding the spectre of even higher inflation rates in coming months.

Equities sold off heavily (imitating, seemingly the 2020 pandemic panic) and worrying about the health of banks, home loans and consumer spending.

The appetite for risk has faded very quickly, leading to a clear sell-off in most sectors. Only energy stocks are surviving, as oil prices remain around their recent highs of $US120 a barrel.

Moody’s economists expect a rise of half a per cent and that “there will likely be some changes to the post-meeting statement, and the committee will release a new Summary of Economic Projections including the so-called dot-plot.”

As Wall Street shares slumped on Friday, yields on the two-year Treasury note, which moves with interest rate expectations, rose above 3%.

The last time the two-year note surpassed this psychologically significant level was in 2008 in the GFC. The US 10-year bond rate closed at 3.16% on Friday, a new year to date high for this key yield.

The yield on the five-year Treasury bonds topped the yield on the 30-year bond, an indication the market believes that the Fed’s campaign of raising rates could tip the US economy into recession.

The Fed will release its new economic and interest rate forecasts at 2pm (4am Sydney time Thursday) Wednesday in Washington. But it’s what Powell says about rate hikes over the rest of the year that will help set the course for worried markets.

“I think really, the key thing is what Powell talks about in the conference and does he give anything that sounds like firm guidance for September,” said Michael Schumacher, head of macro strategy at Wells Fargo. “If he does, he would only do it if he was going to be hawkish, and if he doesn’t, people will view it as dovish.”

US traders are now pricing in three half a per cent rate hikes for June, July and September, which was one more thane expected before the CPI release.

Economists at IHSMarkit/S&P Global wrote late last week that “Market sentiment remains weak at present amid concerns over stubborn inflation and the impact of high prices on growth.”

“While a 50 basis point hike appears to be the forgone conclusion at this point… the Fed’s rhetoric and projection will be eagerly followed for indications on the path forward and the resultant impact that will play into growth forecasts.”

The US retail sales data for May, as well as industrial production for May will be released, but it will be all about the Fed.