Equities rise as recovery optimism abounds
Prior week summary
The major U.S. equity indices continued to march higher last week while yields pulled back amid strong economic data releases, dovish comments from the FOMC, fiscal stimulus bill developments, and an improving COVID-19 situation in the U.S. The yield on the 10-year Treasury fell approximately five basis points over the week, bringing the 10-year yield below 1.7% to 1.67%. While mid and long-term yields have seen a significant run-up since the turn of the year, the 10-year Treasury has traded in a tight range since the beginning of April as investors digest the dovish commentary from the Federal Reserve coupled with the expected $2+ trillion fiscal stimulus bill that aims to pass later this year. Much of the increase in yields since the beginning of the year has been attributed to a rise in inflation expectations with the 10-year breakeven inflation rate, calculated as the difference in yield between the 10-year Treasury and the 10-year TIPS, touching multiyear highs in the last two weeks. With inflation expectations on the rise, Federal Reserve officials have been quick to label the price increases seen in several economic releases as “transitory,” and in a recent switch of policy, have indicated that they will rely more heavily on observed price increases rather than expected price increases to guide monetary policy. According to the minutes of the latest FOMC meeting, released Wednesday, officials indicated that the $120 billion per month in asset purchases would continue for some time and that a change to the program would be forecasted well in advance with the minutes reading, “Participants noted that it would likely be some time until substantial further progress toward the Committee’s maximum-employment and price-stability goals would be realized and that, consistent with the Committee’s outcome-based guidance, asset purchases would continue at least at the current pace until then,” and emphasizing, “A number of participants highlighted the importance of the Committee clearly communicating its assessment of progress toward its longer-run goals well in advance of the time when it could be judged substantial enough to warrant a change in the pace of asset purchases. The timing of such communications would depend on the evolution of the economy and the pace of progress toward the Committee’s goals.” Market participants will have to wait until the end of the month for the next FOMC meeting with several key pieces of economic data, including the Consumer Price Index, released in the lead-up to the meeting.
Optimism for a robust U.S. recovery in Q2 and beyond has continued to grow among market participants in recent weeks. Last week was no different as investor sentiment improved over the course of the week on the back of strong economic data releases. The ISM Services Index surged to an all-time high in March posting a 63.7 level, 8.4 points above the February reading, and well above analyst calls for a 59.0 reading. Every service industry highlighted in the report saw gains in March with the entertainment and recreation industry leading the charge as state and local governments around the country ease restrictions in light of declining COVID-19 case counts and significant vaccine adoption. Notably, the all-time high for the ISM Services Index comes only days after the ISM Manufacturing Index posted its best reading since 1983. The big beats in recent manufacturing and service industry data have fueled expectations for a strong second quarter. The Atlanta Fed’s GDPNow tool, which attempts to forecast the current quarter’s GDP in real-time, now forecasts Q2 GDP to clock in at a robust 6.0%. Jobless claims continued to rise last week with 744,000 claims reported for the week ended April 3. The 744,000 reported claims were well above consensus estimates and marks the second consecutive increase indicating a choppy labor market recovery. Continuing claims remained on the decline reporting 3.73 million claims, a one-year low. Heads turned on Friday when the Producer Price Index (PPI) reported input prices rose 1% in March, double both the consensus estimate and February’s reading. Notably, the core PPI, which excludes the often-volatile food and energy components, increased 0.7% in March, suggesting that inflationary pressures are firming . Digging into the report, the cost of goods rose 1.7% in the last month while the services costs segment rose 0.7%. Finally, the February wholesale inventories release modestly topped expectations notching a 0.6% increase.
Lobbying and negotiations kicked off last week on President Biden’s $2+ trillion infrastructure proposal. President Biden suggested last week that he and the Democrats may attempt to pass the legislation through a special budget process, similar to the passing of the American Rescue Plan Act, but indicated that he would listen to input from “any Republican who wants to get this done.” Republicans, broadly, are opposed to both the size of the bill, as well as the proposed corporate tax rate increase from 21% to 28%. Both chambers of Congress will return to Washington next week, and Biden plans to hold bipartisan discussions on Monday. Interviewed on Sunday, Speaker of the House Nancy Pelosi indicated that she is open to bipartisan negotiations saying, “The door is open. Our hand is extended. Let's find out where we can find our common ground. We always have a responsibility to strive for bipartisanship.” Earlier in the week, Pelosi expressed hope that the bill could be passed by July.
The look forward
Market participants will be looking forward to the release of updated figures on the Consumer Price Index, retail sales, jobless claims, industrial production, the Empire Manufacturing Index, and the Philadelphia Fed Business Outlook Survey, among others. Several Federal Reserve officials hold speaking engagements throughout the week.
Market implied policy path (Overnight indexed swap rates)
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