Market Perspective for May 20, 2016

Fed officials’ recent statements and FOMC meeting minutes pointing to a June interest rate hike led to increased volatility this week that gave way to a Friday rally.

The Federal Reserve generated a significant shift in interest rate expectations. The futures market odds of a June hike were at 4 percent just a week ago, but have rapidly climbed to 30 percent.

There were two key passages in the FOMC minutes from April’s meeting that caught investors’ eyes. The first related to economic data, asserting that stable labor conditions and growth, in tandem with good inflation numbers, could prompt the Fed to increase rates in June. Economic growth has picked up since that meeting, labor market conditions have strengthened and inflation has made progress towards that 2 percent objective.

Other members addressed low interest rates expectations:

Some members expressed concern that the likelihood implied by market pricing that the Committee would increase the target range for the federal funds rate at the June meeting might be unduly low.

Although the Fed has communicated ambiguously in recent sessions, a rate hike does indeed appear more likely this summer. The Fed is unlikely to hike interest rates around the time of the presidential election, and the only post-election meeting is in December, increasing the odds of a summer hike.

Although it was a choppy week for stocks, a Friday rally lifted the major indexes into the black. The financial sector gained around 2 percent, while the SPDR S&P Regional Banking ETF (KRE) gained more than 5 percent. Rate sensitive utilities fell on the week, down about 2 percent. Real estate and consumer staples were also down for the week. In the commodity space, oil rallied to near $50 a barrel before settling back in the high $40s. Copper and industrial metals fell on the week, as did gold and silver. The U.S. dollar index was up nearly 1 percent and the 10-year treasury yield gained a similar amount, to a yield of 1.8 percent.

Home Depot (HD), the world’s largest home improvement retailer delivered better-than-expected earnings and raised its first full-year guidance despite an unexpected drop in same-store sales. Their primary competitor, Lowe’s (LOW) also beat expectations on Wednesday. Wal-Mart (WMT) delivered better-than-expected quarterly profits and same-store sales doubled analysts’ estimates at 1 percent. Target (TGT) beat earnings estimates, but revenues lagged. Like other brick-and-mortar retailers that reported last week, the company’s shares fell approximately 10 percent on the news. In non-retail earnings, Cisco (CSCO) shares climbed 5 percent following an earnings and revenue beat due to strong demand in Asia.

Inflation, housing and labor market data indicate a strengthening economy. The Empire State manufacturing index for May missed estimates and fell to a negative 9.02 reading versus the anticipated 7.25, which indicates a manufacturing slowdown in the New York region. On Tuesday, April CPI in the United States, however, posted its largest gain in three years led by rents, medical care and gasoline, with core CPI rising 0.2 percent. Rent and medical care prices have been pushing core CPI higher, but if energy can hold at $50 or higher, headline inflation will climb above 2 percent by the end of this year or early in 2017. Housing data was strong as well, with both building permits and housing starts coming in higher than expected.

On Friday, existing home sale for April exceeded estimates, with growth of 1.7 percent over last year. March’s sales growth was revised higher to a 5.7 percent growth rate. Leading economic indicators rose to 0.6 percent, according to a report released on Thursday, which was more than expected. On Thursday, weekly unemployment claims totaled 278,000, which was slightly above estimates.

This week the Atlanta Federal Reserve lowered its GDPNow forecast for the second quarter from last week’s 2.8 percent down to 2.5 percent due to lower residential housing investment in April. The New York Fed’s GDP Nowcast increased its estimate of GDP growth to 1.7 percent.

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