Fed could be a surprising catalyst for markets over holiday week

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Traders on the floor of the New York Stock Exchange.

Source: NYSE

The quiet holiday week ahead could see fireworks in store for investors if the Federal Reserve releases its deliberations on its bond purchase program.

Stocks could drift in the four-day trading week after hitting new highs last week. The closely watched 10-year Treasury yield has stayed below 1.5%, a positive reading for tech companies that outperformed, up 3.2% for the week.

Aside from Tuesday’s ISM services data, there are very few economic reports. But the Fed’s minutes of its last meeting will be released on Wednesday afternoon, and the market could learn more of the central bank’s behind-the-scenes discussions about the abolition of its quantitative easing program.

“Our baseline is that rates are drifting up, but to get that spike you need a catalyst to get there,” said Brian Daingerfield, head of G10 FX Strategy Americas at NatWest Markets. “Either the Fed has to be aggressive on tapering, or you really have to get the data going, and neither have you.”

Friday’s report that 850,000 jobs were created in June was better than expected. However, the unemployment rate fell short of expectations after rising 0.1 percentage points to 5.9%. Economists expected a decline to 5.6%. The report was not seen as strong enough to encourage the Fed to pull away from its loose policy sooner. However, it was seen as a positive – albeit largely incomplete – picture of the labor market.

Daingerfield said the Fed’s June minutes of the meeting had the potential to surprise the market, much like the April minutes did.

“Remember, Powell said they weren’t talking about tapering,” he said, referring to Fed Chairman Jerome Powell’s comments right after the April meeting. “Remember, Powell was very dismissive, and then the minutes revealed some kind of drift for the committee.”

April’s minutes of the meeting took investors by surprise when they found “a number of attendees” said it was appropriate to begin discussing tapered bond purchases at upcoming meetings if the economy continues to make rapid progress. After the June meeting, Powell revealed early-stage discussions about reducing bond purchases. The Fed also released a new forecast that included two rate hikes in 2023 where none were previously stated.

The market is very sensitive to details about the Fed’s bond purchase program, as the expiry of this measure would open the door for the central bank to a rate hike. The low interest rate environment has been the catalyst for robust equity market gains since the Fed did everything it could to help the economy cope with the pandemic. The $ 120 billion cut in monthly bond purchases would be the first undoing of these extraordinary measures.

“We don’t know much about the Fed thinking about tapering,” Daingerfield said. He said the most important information is when the program is due to start, how soon the program is due to end, and how it decides to break down its current monthly purchases of $ 80 billion in government bonds and $ 40 billion in mortgage securities.

“These details are really important. Did you even get into this conversation about details? The more details you went through, the more likely it is that you will move forward faster,” Daingerfield said. Fed watchers widely await more details on the debt throttling program at their annual symposium in Jackson Hole, Wyoming in late August, and then begin slowing buying later this year or early 2022.

The positive tone on the bond market has helped stocks for the time being. The 10-year yield, which is moving against price, has fallen from its annual high of around 1.75%. At this level, technology and growth stocks have been under pressure.

But they’re making a comeback as rates hover in a range below 1.6%. The 10-year price was 1.43% on Friday, and while the lower rate could help tech stocks, the yield level is in sharp contrast to an economy expected to grow more than 10% in the second quarter.

This pace is expected to slow, but growth for the year is expected to be robust at more than 7%.

Technology transition

Steven Wieting, chief investment strategist at Citi Private Bank, said the time has come for investors to move from popular cyclical trading to technology and growth stocks as the economy peaks.

“We see all of this as a temporary period of massive distortion, and in a year we will be on calmer waters,” he said. “I think this gives people, including us, a reason to move from just cyclical rebound trades to some sustainable growth opportunities.”

In the year to date, cyclical stocks have been among the better performers. Energy stocks are up 44.5% with the rebound in oil prices, and financials are up 25.2%. In contrast, the S&P 500’s growth stocks are up 14.3%, slightly behind the S&P 500’s profit of 15.5%. Tech stocks are only up 14.9% since the start of the year.

One area Wieting likes now is global health care. The S&P 500 healthcare sector grew 12.5% ​​year-to-date.

“Healthcare is outperforming mid-cycle. Healthcare is a part of the economy that hasn’t fallen as much, ”he said. “Profits and sales have grown moderately every year since the mid-1980s.” He said the sector has lagged the S&P 500 by 10 percentage points since late 2019 and has a cheap valuation. Big pharma stocks are among the best dividend payers.

For major sectors, cyclical Industrials, Materials and Energy are all up more than 40% on a 12 month basis and the Technology sector has seen a similar increase of 42%.

“The growth stocks stayed rich. Value stocks fully overtook growth stocks in 12-month performance, but it didn’t beat growth stocks valuation, ”he said. “After this phase where it flattens out, we will gradually get more sustainable performance out of the technology.”

Wieting said a particularly attractive area is cybersecurity, where demand is strong as a “major technology spend,” but the sector has gone nowhere.

For example, the iShares Cybersecurity and Tech ETF IHAK is just below its 52-week high from January, and the Global X Cybersecurity ETF BUG is trading about a dollar below its February high.

Wieting said he likes some alternative energy names and companies involved in digitization, including fintech.

He expects the stock market to move higher overall, but not at the same quick clip.

“We want to start moving portfolios away from pure rebound games … We are preparing for the move because we know we have outperformed cyclically over the past year. It made people enjoyable to invest in stocks when we could show how cheap they were. “” He said.

The S&P 500 ended the week up 1.7% to a record 4,352 while the Dow climbed 1% to 34,786. The Nasdaq was up 1.9%, finishing the week a record high of 14,639.

Calendar for the week in advance

Monday

Independence Day holiday observed

Tuesday

9:45 a.m. Service PMI

10:00 am ISM services

Wednesday

10:00 a.m. JOLTS

2:00 p.m. FOMC protocol

3:30 pm Atlanta Fed President Raphael Bostic at the National Association of Black Journalists’ event

Thursday

8:30 a.m. unemployment claims

3:00 p.m. Consumer Credit

Friday

10:00 a.m. wholesale