The stock market declined amid rumors the U.S. Federal Reserve is considering raising interest rates sooner than previously expected.
The Week That Was
Reports show the economy continues to move at a rapid pace. A sharp decline in retail sales in May was attributable primarily to extraordinary increases in March and April. Even after the decline, May retail sales were up at a 70 percent annual rate from the first quarter.
Manufacturing activity in May rose 0.8 percent, a 10 percent annual rate. The Homebuilders’ Index for early June fell to 81, amid shortages of building materials. A reading of 81 indicates the market for new homes remains very strong.
Weekly initial claims for unemployment insurance for early June have settled in the vicinity of 400,000. It has been in this vicinity for the past four weeks.
Producer prices for finished goods increased by 1 percent in May, another indication inflation will remain high in the months ahead.
Things to Come
The most interesting report this week will be Wednesday’s Markit survey of business conditions in early June. Recent reports have tended to hit new record highs for increases in business activity. At some point the upward momentum will slow a bit. It will be interesting to see whether there are any preliminary signs of a slightly less hectic pace of activity in Wednesday’s report.
Thursday’s report on new orders for durable goods in May should continue to show new orders at or exceeding recent record highs.
Friday’s report on consumer spending and wages for May will provide the most comprehensive view of activity for the middle of the second quarter. This report will help indicate whether second quarter growth was as strong as the first quarter. Other data suggest it was.
Stocks were mostly lower last week, with significant weakness on Friday. Most
commentary attributes the latest weakness to a change in the Fed’s timing for increasing interest rates. Fed members now expect to raise the fed funds rate by 0.5 percent in 2023. They previously expected no change through 2023.
One high Fed person known for his dovish stance on interest rates talked about possibly raising rates in 2022. We can expect all such comments regarding higher interest rates to lead to a temporary setback in the stock market.
Except for the Nasdaq and QQQs, Friday’s decline sent all major indexes below their 50-day averages on higher volume. As a result, technical indicators have weakened considerably for all but the Nasdaq indexes. With stocks currently 23 percent above their fundamental value, a weakness in technical indicators can be a prelude to some further selling pressure.
Most monetary indicators continue to point to a highly stimulative policy. However, there are tentative signs of a possible shift to a less expansive policy.
For now, with most monetary indicators continuing to point to expansion, the most likely development is for only a limited setback in stocks.
As for interest rates, they immediately responded to the Fed’s new time table. Two-year Treasury rates rose and longer-term rates declined sharply.
This interest rate response appears to assume a mere suggestion of a modest hike in short-term interest rates will vanquish inflation. Inflation won’t give up that easily.
Both any likely decline in stock prices as well as the current decline in long-term interest rates are likely to be temporary developments.
Economic Fundamentals: positive
Stock Valuation: S&P500 overvalued by 23 percent
Monetary Policy: expansive