Overview: Stocks were mixed across the globe last week, with international stocks notching positive returns, and U.S. stocks ending the week lower. Emerging market equities (MSCI EM) led the way with a 1.8% return while international developed stocks (MSCI EAFE) notched a positive 1.1% return. In the U.S., inflation concerns continued to be a focus of investors, despite the Federal Reserve’s view that the recent pick-up in inflation is likely transitory. The S&P 500 index finished the past week -0.4 % lower, but remains firmly in positive return territory for the year. In the bond markets, U.S. Treasuries held steady last week, with the 2- and 10-Year yields closing at 0.16% and 1.63%respectively. Markets are now watching for signs that the Federal Reserve will consider raising rates or trimming bond purchases earlier than anticipated, and this has added volatility to the markets. Forward guidance from the Fed may be updated if the economic recovery continues to make rapid progress. Economic data was generally positive last week, highlighted by the initial jobless claims falling to 444,000 for the week. Weekly claims continue to trend lower, and are approaching the pre-COVID average of 350,000 as the economy continues to improve.
A Note on Inflation (from JP Morgan): The U.S. TIPS/Treasury breakeven rate, which is the difference between the nominal yield on the Treasury and the promised real yield on Treasury Inflation-Protected Securities (TIPS) of the same maturity, is often used to value the market’s expectation of future consumer price index (CPI) inflation. Recent upward momentum in such breakeven rates suggests that some investors have radically upgraded their views concerning inflation over the next 5, 10, 20 and 30 years. Long-term inflation expectations are now far above their 2020 lows. Nowhere is this more notable than in the 5-year breakeven rate, which hit a 10-year low of 0.2% in March 2020 and has since increased by 2.6 percentage points, as of last week, to its 10-year high of 2.8%. Longer maturity breakeven rates have also increased dramatically, and now all sit comfortably above the Fed’s long-run goal, even recognizing that the CPI inflation rate normally runs 0.3% higher than the Fed’s preferred personal consumption expenditure (PCE) deflator target. Another signal comes from the Philadelphia Fed’s 2Q21 Survey of Professional Forecasters, which predicts that headline CPI inflation will average to 2.3% over the next decade. It is notable that this 10-year prediction has been revised upward each quarter over the last year. Higher inflation expectations beg the question of when the Fed may begin to raise rates. As higher inflation materializes, investors may want to be positioned in value stocks, real assets and inflation-protected bonds as these securities fare better in a hotter inflationary environment.
Sources: JP Morgan Asset Management, Goldman Sachs Asset Management, Barron’s
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