The Fed Or A Bout of Seasonal Weakness?

Most commentaries attributed last week's stock market sell-off to a more hawkish Fed projection of the fed funds rate.  Such attribution is questionable, as discussed below.  What makes more sense is an early start of seasonal market weakness in late June that tends to last for 10 days or less and subsequently is quickly made up. 

Commentators' attribution was based on an upward shift in the number of FOMC participants who think it likely the funds rate will rise in 2022 and 2023.  The problem is that these long-term forecasts are not reliable and should be taken with a grain of salt, as Fed Chair Powell said in his post-meeting conference.  In fact, the thrust of his entire post-meeting new conference was the importance of achieving the Fed's goal of full employment -- an argument for continuing easy policy.  He gave reasons why the currently high inflation prints are likely temporary.  And, he mentioned that some of the longer-run factors holding down inflation -- foreign competition,  technology, etc. -- would probably continue to be in effect in coming years.

The  FOMC participants expectations of the funds rate through the next two years is shown in what's called the "dots" chart -- because there is a dot for each participant's expectation.  The "dots" chart showed the number of FOMC participants who expect the funds rate to be hiked in 2022 rose to 7 from 4 in the prior March chart.  The number rose to 13 from 7 in 2023.  Eleven participants did not expect any rate hike in 2022 and five in 2023.   Powell seemed to dismiss the significance of the rate forecasts for being highly uncertain.  The Statement, itself, essentially did not change, implying steady easy policy at this point.

While many commentators mentioned the higher growth and inflation in the Fed's Central Tendency Projections, they failed to realize that most of the increases reflected the high prints already seen.  My calculations suggest that the upward revision in the Fed's projection of the 2021 Core PCE Deflator to 2.9-3.1% (Q4/Q4), for example, assumes about a 2.0% annualized rate of increase over H221.  This is not an excessive pace and puts it in line with the Fed's longer-run projection over the subsequent two years.  The Fed's 2021 projection of 6.8-7.3% (Q4/Q4) Real GDP Growth assumes 5.3-6.3% over H221, using the Atlanta Fed model's current estimate of 10.3% for Q221.  The H221 pace would be substantially slower than the 8.4% pace of H121.  The Fed sees Real GDP Growth falling back toward trend in the following 2 years.

Fed officials will have opportunities to clarify their policy stance this week.  The two most important should be Powell, who testifies on the coronavirus and the economy on Tuesday, and NY Fed President John Williams on Monday.  Both represent Fed leadership and are likely to emphasize the steadiness of easy monetary policy, the transitory nature of recently high inflation figures and the Fed's goal of full employment.  Other Fed District Bank Presidents will speak as well, including St Louis Fed President Bullard, who gave a hawkish spin to the meeting's results on Friday.  He appears to be in the minority of FOMC participants, however, as he said he expects a rate hike in 2022.

While there is not enough significance in the outcome of last week's FOMC Meeting to warrant a major negative stock market reaction, the S&P 500 Index has a history of short-lived pullbacks towards the end of Q2.  To illustrate using the past 5 years, the Index peaked around June 20 and then fell for 10 days or less (see table below).  The decline could be sizable or modest.  However, they were all erased by early to mid July.   This seasonality appears to be well known, as it was discussed on CNBC.  This may explain why it began a bit early this year.  

                  Seasonal Weakness in S&P 500 Index

 Peak            Trough        Peak Regained        Peak-Trough Change   

 6/19/20        6/29/20        7/2/20                            -3.9%

 6/21/19        6/27/19        7/1/20                            -1.1%

 6/20/18        6/28/18        7/9/20                            -2.6%

 6/20/17        6/28/17        7/17/17                          -0.9% 

 6/24/16        6/28/16        7/1/16                            -4.6%

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6/14/21                                                                   -2.1% to date

This week's US economic data are expected to paint a picture of strong demand in manufacturing and mixed demand for housing, along with high inflation.  There are downside risks, however.  Consensus looks for a 2.7% m/m rebound in May Durable Goods Orders, with Ex Transportation up 0.7%.  But, some of the recent strength could have overstated trend, and there could be payback.  Consensus also looks for an increase in May New Home Sales but a decline in Existing Home Sales.  The decline in May Housing Permits, however, suggests a decline in New Home Sales, as well.  Consensus looks for -2.5% m/m in May Personal Income, as government transfer payments unwind.  This could underscore Fed Chair Powell's comment that an end to fiscal stimulus is one reason to expect slower economic growth ahead.  The consensus estimate of +0.3% m/m in May Consumer Spending is modest.  But, March and April Consumer Spending should be revised up, as were Retail Sales in those months.  The Core PCE Deflator is seen at +0.6% m/m, versus +0.7% in April.