Equity markets were relatively flat this week although it was a bumpy ride due to a large number of options and futures expiries, these tend to create volatility as traders close out positions. All eyes were on the U.S. Federal Reserve this past week. And, it did not disappoint, at least with respect to the buzz generated within the investment community. The Fed, as it is often referred to, appears to be preparing for a shift in its approach to monetary policy. While there was some weakness in bonds and segments of the equity markets, the most notable action occurred in the currency markets. We explain more below.
The U.K. continued to struggle with the Delta variant this week and delayed their final reopening stage by another month. While this is worrisome it is also important to note that the U.K. relied heavily on the AstraZeneca vaccine that has shown less efficacy against this Delta variant than the mRNA vaccines that have been used more widely in North America. Importantly, U.K. deaths and hospitalizations have remained at very low levels.
Canadian case numbers continued to plummet this week although we are now reaching the stage of the pandemic where hospitalizations and deaths are becoming the more relevant data with such a large proportion of the highest risk populations now fully vaccinated. Canada appears poised to hit the 75% first dose – 25% second dose mark this weekend, and we are on pace to reach 78-33 by Canada Day. The Trudeau Liberals announced another month of border closures today and drew the ire of U.S. politicians with Congressman Brian Higgins going to Twitter and declaring it “B.S.”
The Globe and Mail reported today that “Opposition parties voted Thursday to declare the Liberal government in contempt of Parliament for refusing to provide unredacted documents to the House of Commons that could explain the firing of two scientists from Canada’s top infectious disease lab in Winnipeg, amid concerns over their ties with Chinese military research. The attempt by MPs to formally demand the confidential information is significant because it is the first time the House has ever passed a motion that censures a public servant – Mr. Stewart – for refusing to co-operate with MPs. The motion adopted by the Conservatives, Bloc Québécois and NDP censures the Public Health Agency of Canada (PHAC) for failing to produce the requested records. It also orders PHAC President Iain Stewart to appear before the Commons on Monday to be admonished and to produce the confidential documents. ”
The Globe also reported this week that: “Hundreds of vaccinated Indonesian health workers contract COVID-19, dozens in hospital.” Only after one had clicked on the headline did they reveal that it was the far less effective SinoVac vaccine that the health workers had received.
Inflation and Interest Rates:
This past week, the Fed provided an update on its economic and inflation projections as well as the anticipated path it foresees for interest rates and bond purchases. Investors had been accustomed to a Fed that had to this point exhibited substantial patience and resisted the temptation to alter its approach despite a domestic economy that has improved and pricing pressures that have surfaced. As a result, some investors were surprised by the new estimates and comments released this week that suggest policymakers are preparing for a transition away from ultra-accommodative monetary policy.
The Fed’s projection for economic growth for the year was revised higher, but its inflation forecast saw the biggest boost, with the estimate now expected to be slightly above its preferred target through the next few years. Moreover, Chairman Jerome Powell acknowledged that while they still view the uptick in inflation as temporary in nature, there is the possibility it could be higher and longer lasting than expected. He indicated that committee members have begun to talk about when to start reducing their monthly bond purchases which they have been using as another means of fostering favourable financial conditions. Many expect a formal announcement of such a plan later this summer.
Not surprisingly, investors zeroed in on the fact that an increasing number of Federal Reserve committee members moved up their estimated timeline for interest rate hikes. Of the 18 members, 11 expect at least two rate increases in 2023, while 7 see rates potentially beginning to move higher next year, up from 4 members just a few months ago.
The reaction in the markets was noteworthy, particularly amongst currencies. The U.S. dollar rose meaningfully relative to most currencies, putting more pressure on some commodities that had already been weaker of late. But the U.S. currency still has a ways to go to unwind the underperformance witnessed against many currencies since last year. While it has some wind at its sails for now, an improving economic backdrop outside of the U.S. should be more supportive of other currencies.
In the grand scheme of things, the developments this past week were not too surprising. The economic wounds that arose last year have been closing, and the pending shift in approach of the Federal Reserve, and other central banks for that matter, reflect a return to a more normal environment which should come as a relief to many. Nevertheless, interest rate hikes over the next number of years, should they occur, increase the odds of entering an environment where access to credit becomes more difficult. Most major market declines have coincided with recessions, and most recessions have occurred when financial conditions become restrictive. Thankfully, we envision a very gradual transition in monetary policy, and don’t envision those kind of conditions arising any time soon.
Our thanks to all who voted in our Inflation Poll last week, one year inflation expectations under 3.5% received 70% of the vote while 30% said inflation will exceed 3.5% a year from now.
Finally, over the next five weeks we are going to feature a series of short cyber-security reports produced by RBC to educate clients on how to avoid being hacked or security compromised, we start this week with the very recent headline grabbing topic - Ransomware:
Andy, Sacha and Mike
What we were reading this week: