May has been a bit of a roller coaster as volatility has picked up in pockets despite the headline number remaining broadly stable. We saw equities trade lower during the first half of the month (decline led by Tech) and then make up the gains in the second half of the month - Tech playing a major role in the rally as well but the healthcare sector was the standout performer. US yields trended lower with the 10Y first breaking below the 1.60% support and then the 1.50% level and is stabilizing around the 1.45% level for now. The yield curve became flatter which (in theory) is an indicator of pessimism and diminished growth prospects.
Where we go from here is largely a function of the largest central bank in the world. The Federal Reserve (Fed) is set to start its two-day meeting on the 15/16 of June - following which they will announce their decision on the level (and forward guidance) of interest rates; alongside growth, inflation and unemployment estimates for the near term. The market expects them to hold at the current level without any withdrawal of stimulus for at least another year. The 'dot plot' of forward guidance on interest rates is expected to show the first hike only in 2023. With unemployment numbers still far higher than pre-pandemic levels, this seems plausible enough.
The key variable that could play spoilsport though, is inflation. The Fed has maintained that the current spike in inflation has been caused by low base effects from a year ago and that the price increases are 'transitory' and likely to diminish with time. The opposing argument is all the unprecedented easing of the last decade, particularly the last year, has led to abundant liquidity in the system and with inflation expectations picking up, persistent inflation higher than the Fed's 2% target will be here soon. The current evidence is mixed, with support seen for both cases so we will have to wait and see what the Fed has to say on the matter this week.
We expect minimal disruption to markets overall and the recent optimism is likely to continue as economies reopen and demand picks up. We continue to monitor the potential risk factors out there and will position accordingly should there be a change in the underlying data.
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June 15, 2021
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