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A couple of weeks ago, the Federal Reserve seems to have rattled investors by mentioning the prospect of tapering its bond purchases and by adding two potential rate hikes to its forecast for 2023. So I wanted to share some thoughts on what’s going on and what I expect to occur next.
Media headlines keep screaming that the week of June 14 was the worst week for the stock market since last October. But let’s put this in perspective: There have been no significant selloffs for the U.S. stock market in nearly a year. And so yes, it was the worst week for the Dow Jones Industrial Average since October, and the VIX did rise significantly, but the Dow only fell 3.45% in the week.1 And the S&P 500 Index only fell 1.91%.1 In other words, the U.S. stock market selloff may have constituted the biggest selloff of the year, but it was very tame. And the selloff in global stocks was even more muted.
It wasn’t just stocks. The 10-year U.S. Treasury yield also took a bit of a rollercoaster ride because of the Fed. It initially got close to 1.6% on the Wednesday,1 anticipating higher rates because of the Fed’s announcement and subsequent statements. However, then the yield moved lower, with additional downward pressure created by St. Louis Fed President James Bullard’s comments on the Friday. He shared that he could see a rate hike occurring as early as late 2022.2 This sent the yield on the 10-year Treasury below 1.44% on Friday afternoon.1 It seems investors bought up Treasuries and pushed yields lower as they began anticipating a slower economic recovery because the Fed expects to tighten.
We shouldn’t be surprised that the Fed is having such an impact on markets. The Fed has played an outsized role in the stock market since it began providing extraordinary monetary policy accommodation in the global financial crisis over a decade ago. The central bank of the United States has taken on a far more proactive role than it had before 2008, and so moving markets is just part of the deal of having such an activist central bank.
The Fed has increasingly focused on over-communicating with the public since the pandemic began. However, no communication can be flawless or without incident, especially when it’s about monetary policy tightening. What seemed to unnerve investors last week was not tapering – which had been well-communicated in advance – but the change in the dot plot for the fed funds rate (and then the suggestion that the first rate hike might occur even sooner). But while markets were surprised and dismayed to see expectations of two rate hikes in 2023 and the possibility of a rate hike in late 2022, frankly, I was surprised by the market’s surprise. Obviously, the expected timeline for rate hikes is likely to move up given the strength of this recovery, which is far more robust than the recovery following the global financial crisis.
And it’s important to remember that the dot plot is merely each individual Federal Open Market Committee member’s policy prescription – not a binding contract or a plan set in stone. If there is anything we have learned from the Fed, it is that in recent years it has become more holistic in its assessment of when monetary policy action is appropriate. The hard targets have softened and become more nuanced. The Fed will likely not tighten in 2023 if the economy is weaker, and it may tighten as soon as 2022 if conditions warrant.
We’ve seen a recovery for U.S. and European equities as of this writing, which is a positive development and indicates the resilience of the stock market. However, global stocks could certainly experience a significant drop this summer. This is a precarious time – stocks have gone a relatively long period without any major selloff, and there is heightened sensitivity to every utterance from the Fed as it attempts to transition to the start of normalization. But isn’t that what many investors have been looking for?
There has been little opportunity for attractive entry points since last year; this could be that opportunity if there is a hefty selloff. Whether or not investors take advantage of tactical opportunities, I believe it’s important to stay the course for the long haul – to be well diversified across asset classes but maintain adequate exposure to a broad array of equities.
Kristina Hooper is Global Market Strategist at Invesco.
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Notes
1. Source: Bloomberg, L.P.
2. Source: CNBC, “Fed’s Jim Bullard sees first interest rate hike coming as soon as 2022,” June 18, 2021
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An investment cannot be made into an index.
All figures are based on the U.S. dollar.
The Federal Reserve’s “dot plot” is a chart that the central bank uses to illustrate its outlook for the path of interest rates.
The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.
The Dow Jones Industrial Average is a price-weighted index of the 30 largest, most widely held stocks traded on the New York Stock Exchange.
The federal funds rate is the rate at which banks lend balances to each other overnight.
Disclaimer
© 2021 by Invesco Canada Ltd. Reprinted with permission.
The opinions referenced above are those of the author as of June 21, 2021. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties, and assumptions; there can be no assurance that actual results will not differ materially from expectations. Diversification does not guarantee a profit or eliminate the risk of loss. All investing involves risk, including the risk of loss.
Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Investment funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that any fund or security will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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