Most Likely Scenario
June 23, 2021
Last Wednesday’s Summary of Economic Projections from the FOMC included only small upside revisions to inflation forecasts, while the median dot pulled two rate hikes forward to 2023. Taken at face value, the net result (lower inflation forecast/more hawkish on rate hikes) became renewed concerns for a Fed policy mistake. Bond markets responded to the updated dot plot with 2-year and 5-year yields higher, while the Fed’s small upside revision to inflation forecasts had longer-dated bond yields lower. The flatter yield curve pressured cyclical/value equity sectors, while the Nasdaq 100 (NDX) made a new record high last Thursday and again yesterday. Importantly, the yield curve (5/30-year yield spread) held strong secondary support at ~120bps after breaking through much weaker support at ~131bps. Comments from the Fed’s Powell and Williams this week have helped shift the policy narrative away from the timing of rate hikes (updated median dot suggests liftoff is still in the distant future) and back to the timing of tapering asset purchases. The shift in expectations has helped steepen the yield curve to current levels of ~126bps. Value equity sector (Financials, Materials and Energy) performance will recover on a stable-to-steeper yield curve and new equity exposure should stay biased to these groups at levels above ~120bps.
Goldilocks? Growth/Tech sectors should continue working higher as long as 10-year yields remain under ~1.60% and the 5/30 spread stays under ~132bps. A 5/30-year spread between ~120bps and ~132bps should then result in broad equity participation.