The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2021 Outlook:
- U.S. economy: Getting worse before it improves.
- Global economy: Ready to get back to normal—with the help of vaccines.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: A modest-risk overweight with a focus on credit sectors.
- Equities: Lean toward small caps, emerging market shares and dividend payers.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
"May your pockets be heavy and your heart be light. May good luck pursue you each morning and night.” – Irish blessing
Watch the Fed’s juggling act on Wednesday
All Federal Reserve meetings are closely watched, but this Wednesday’s gathering will be of particular interest given the unique set of circumstances facing the U.S. economy and financial markets. Since the Fed’s last meeting in January, we’ve seen the enactment of expansive new fiscal stimulus (the Biden Administration’s $1.9 trillion package was signed into law last week) and increasingly positive news on the COVID-19 front, including dramatic declines in case counts and hospitalizations, and the rapid deployment of safe, effective vaccines. These developments have fueled widespread optimism about resurgent U.S. economic growth, evidenced by rising interest rates in the bond market and a sharp rotation in the equity market toward cyclical (economically sensitive) sectors and value stocks.
Against this backdrop, the Fed has consistently maintained that its accommodative monetary policy remains appropriate. In other words, don’t expect any changes on that front to be announced on Wednesday.
So what can we expect from this meeting?
For starters, the Fed will release a summary of economic projections. We’re looking for a substantial upward revision to the Fed’s 2021 GDP growth forecast, which in December stood at 4.2%.4
The Fed may also make corresponding shifts to its current outlooks for unemployment (5.0% by year-end) and inflation (+1.8%, as measured by core PCE, the Fed’s preferred inflation gauge).4 After all, it would be unrealistic to expect massive government stimulus, coupled with the economy’s continued reopening, not to affect these metrics.
But the Fed has to be careful not to unintentionally hint that tighter monetary policy is on the way. If the Fed forecasts a quicker return to its 2% inflation target, investors might interpret that as an endorsement (or prediction) of an imminent end to its monthly quantitative easing (QE) asset purchases (currently $120 billion/month), and perhaps an earlier time frame for raising the federal funds rate from its 0%-0.25% range.
At this point in the recovery, either form of policy tightening could spark a reaction akin to the 2013 “taper tantrum,” when both equity and bond markets were roiled by then-Fed Chair Ben Bernanke’s suggestion that the Fed might begin reducing its QE purchases. Clearly, Powell and his colleagues would like to avoid a sequel.
Meanwhile, the Fed’s “dot plot” — showing individual members’ projections for interest-rate changes — could offer some reassurance for investors. In particular, they’ll hope that January’s near-unanimous forecast of no rate hikes this year and next remains intact, which could help prevent another tantrum.
Markets will also examine the dots for the Fed’s longer-term interest-rate outlook. At the last meeting, only five out of 17 members expected rates to rise by the end of 2023. That number may increase somewhat.
In addition, the Fed’s policy statement should provide further context for the Fed’s assessment of whether U.S. economic challenges have diminished to the point that current policy may now be too easy. Powell will have the opportunity to elaborate on these matters in his post-meeting press conference.
One dynamic that shouldn’t force the Fed to alter its ultra-dovish stance: transitory inflation scares, like the recent one that quickly drove up long-term Treasury yields. We believe two more episodes of this type could occur in 2021. The first could happen in the next two months, when March and April data are released and last spring’s negative inflation numbers are replaced in the year-over-year calculation by positive, more “normal” data.
Another may take place over the summer. In industries such as dining, travel and leisure, which have been especially hard hit by the pandemic, sharply rising consumer demand may temporarily swamp available supply. Powell has already promised not to react to temporary inflation increases in 2021, which would include a period in which businesses are quickly staffing up to expand their capacity in the face of surging demand. We believe investors will be best served by following the Fed’s lead (ignore short-term inflation headlines) and by sticking to their long-term asset allocation plans.
At the same time, the Fed would lose credibility if it tried to downplay the likelihood of substantial recoveries in the labor market and overall GDP this year. So to assuage market fears of imminent tightening, Powell will probably emphasize how far the economy has to go to recover from last year’s COVID-19-fueled damage. Even in an upside scenario, unemployment is unlikely to return to its pre-pandemic low of 3.5% this year, especially if the labor force increases, as we hope and expect.5
When economic data not only tops forecasts, but also does so sooner than expected, central banks can find themselves in a delicate situation. In this age of extreme transparency at the Fed and its global peers, that can make for some awkward transitions and clarifications. But we believe rhetorical guidance, rather than actual policy changes, will do the hard work of monetary policy this year.
Did you know?
In a week filled with mostly good news, including (1) a solid week on Wall Street, (2) an even better one in Europe and (3) a drop in first-time jobless claims to a four-month low, we noticed sentiment surveys released last week still paint a mixed picture.6 For example:
- March’s preliminary University of Michigan Consumer Sentiment Index hit a one-year high. Assessments of both current conditions and consumer expectations improved significantly. These are consistent with recent upbeat spending data reflecting sharp declines in COVID-19 cases, hospitalizations and deaths.7
- Large companies are also bullish, with the first quarter’s CEO Economic Outlook Survey signaling optimism for an economic recovery in the months ahead. Notably, 72% of respondents indicated that their businesses have already recovered or will have recovered by year-end. Plans to boost hiring and capital investment all rose significantly, as did sales forecasts.8
- In contrast, the NFIB’s Small Business Optimism Index increased only slightly in February and stayed below the survey’s 47-year average. According to the NFIB press release, “The recovery remains uneven for small businesses,” with 40% of respondents unable to fill open positions, up substantially from January. And expectations for better business conditions over the next six months remained at low levels.9
U.S. consumers and large businesses have adapted reasonably well to the pandemic, with the help of the federal government. But many small businesses continue to struggle and may soon encounter a new type of risk: how to accommodate an unprecedented surge in demand as consumer preferences shift quickly away from goods and toward services. We expect a rapid increase in hiring in the coming months and, potentially, greater price pressures as companies face supply chain challenges and higher input costs.