Hawkish Fed Surprise Upends the Markets…..

U.S. equities were able to climb off their lows of the day, but stocks finished lower following a day full of data and surprising events. The midday tumble came courtesy of a surprise from the Fed following its policy meeting, where the central bank sharply increased its inflation expectations and pulled forward its forecast of when interest rates could begin to rise. Beforehand, investors sifted through another mixed bag of economic data that showed disappointing housing construction numbers, a rise in mortgage applications, and more data indicating a heat up in pricing pressures. Treasuries fell following the Fed meeting and the U.S. dollar finished solidly higher, while gold tumbled and crude oil prices were nearly flat. On the equity front, Oracle topped Q4 earnings estimates but offered disappointing Q1 guidance, General Motors upped its investment in electric vehicles, and Citigroup was the latest bank to warn of lower trading revenues in Q2. Markets in Europe and Asia finished mixed amid cautious trading ahead of the Fed’s decision.

The Dow Jones Industrial Average declined 266 points (0.8%) to 34,034, the S&P 500 Index lost 23 points (0.5%) to 4,224, and the Nasdaq Composite shed 33 points (0.2%) to 14,040. In heavy volume, 1.1 billion shares were traded on the NYSE and 4.6 billion shares changed hands on the Nasdaq. WTI crude oil ticked $0.03 higher to $72.15 per barrel. Elsewhere, the Bloomberg gold spot price fell $27.82 to $1,831.20 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—jumped 0.7% to 91.17.

Fed stands pat, but raises inflation expectations…..

The Federal Open Market Committee (FOMC) concluded its two-day monetary policy meeting today, opting to leave its stance and interest rates unchanged, as was widely anticipated, and there was also no change to its asset purchases. However, the Committee sharply raised its expectations for inflation this year and pulled forward the timeframe of when it could begin to raise interest rates, surprising the markets.

In its statement, the Committee said, “Progress on vaccinations has reduced the spread of COVID-19 in the United States. Amid this progress and strong policy support, indicators of economic activity and employment have strengthened.” On inflation, it noted that prices have risen, but it still deems it as “transitory,” while it also continued to reiterate its intentions to aim for an average of two percent over time, and that longer‑term inflation expectations remain well anchored at two percent. However, in the updated economic projections provided with its statement, it upped its projection for PCE inflation to 3.4%, a full percentage point from its March estimate, and the core PCE, which excludes food and energy, to 3.0% from the previous meeting’s 2.2% forecast. As well, the Committee increased its estimate for real GDP to 7.0%, a one-half percentage point above March’s reading. As such, the Fed’s “dots plot” showed that members saw a liftoff of rates could come as soon as 2023, whereas it saw no increases until at least 2024 at its last meeting.

In his scheduled press conference following the statement, Chairman Jerome Powell said that the effects of bottlenecks on inflation have been larger than anticipated, and that inflation could turn out to be higher and more persistent than previously thought. As such, Powell said that the Committee is prepared to adjust policy if pricing pressures move too high, but any needed change to its policy would remain accommodative.

Housing starts for May rose 3.6% month-over-month (m/m) to an annual pace of 1,572,000 units, below the Bloomberg consensus forecast of 1,630,000 units, and compared to April’s downwardly-revised pace of 1,517,000 units. Building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, fell 3.0% m/m at an annual rate of 1,681,000, south of expectations calling for 1,730,000 units, and compared to the negatively-revised 1,733,000 unit pace in April.

The Import Price Index increased 1.1% m/m for May, compared to expectations calling for a match of April’s upwardly-revised 0.8% increase. Versus last year, prices were up by 11.3%, compared to forecasts of a 10.9% increase and April’s upwardly-adjusted 10.8% gain.

The MBA Mortgage Application Index rose by 4.2% last week, following the prior week’s 3.1% decrease. The increase came as the Refinance Index gained 5.5% and the Purchase Index was 1.6% higher. The average 30-year mortgage rate declined 4 basis points (bps) to 3.11%.

Treasuries fell following the Fed’s announcement, as the yield on the 2-year note rose 4 bps to 0.20%, the yield on the 10-year note jumped 8 bps to 1.57%, and the 30-year bond rate moved 2 bps higher to 2.20%.

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