It wasn’t terribly difficult to write the boilerplate copy headed into the weekend.
Just days removed from what some traders initially described as “a momentous markets turning point,” US equities hit a new record high after logging their best week since February (figure below). The VIX, meanwhile, dropped to pre-pandemic levels.
Fed officials didn’t so much “walk back” the hawkish lean inherent in the June dot plot as much as they did walk a tightrope during a dizzying series of speaking engagements capped by Eric Rosengren, who reiterated a version of state-dependent forward guidance during an interview on Friday. He wouldn’t identify his dot, but said it’s possible the Fed could meet its objectives by the end of next year.
The data suggested affordability is starting to bite the US housing market, where record high prices appeared to weigh on demand, even as supply constraints make it difficult to draw conclusions. PMIs betrayed the usual concerns over surging input prices and bottlenecks. Jobless claims are acting stubborn. And Friday’s inflation data was cooler than expected on the monthly prints.
Following the post-Fed fireworks which found the curve power-flattening into a fairly dramatic long-end rally, Treasurys reversed course, with 10-year yields posting their biggest weekly jump in months (figure below). Friday saw 10s as high as 1.54%.
“Treasurys are in a definable range with 10s content to hold 1.35% to 1.59%… until there is enough cause to further refine the macro outlook,” BMO’s Ian Lyngen and Ben Jeffery said Friday afternoon. Although they conceded that June NFP could potentially move the needle, they suggested “an extended period of consolidation appears far more likely than another fundamentally driven repricing.”
Why? Well, two reasons. First, Lyngen said that even as the Fed is “by no means hawkish,” the new dots “demonstrated its ongoing commitment to maintaining its hard-earned reputation as a credible inflation-fighter.” Second, he wrote that there’s “plenty of fundamental justification for ignoring the data at this stage in the cycle, not least of which being the ongoing lack of context for the magnitude of the surprises/misses.”
In equities, value was back en vogue, outperforming growth (figure below) as the reflation trade regained some swagger amid higher yields, infrastructure optimism and a blockbuster week for banks, which very nearly erased the entirety of last week’s 7.8% drop.
Small-caps had their best week since March, and despite growth’s underperformance (versus value), big-cap tech still posted a 2% gain, the Nasdaq 100’s sixth weekly advance in a row. (Everyone’s a winner!)
Time and again over the past several days, I’ve reiterated that the post-FOMC trade was exacerbated by positioning and a generalized washout, which created a number of false optics, including what looked like a growth scare in the curve. This week was less manic, but for many, having to ask “Is this a ‘reflation’ week or not?” is probably a bit vexing.
“Taking a step-back, this ‘reflation on, reflation off’ qualitative observation captures the ‘grinding chop’ that has been the year-to-date performance theme, as too much tilt to either ‘Reflation’ or longer-term legacy weighting to ‘Duration’ each would have exposed you to very distinct periods of grinding small returns, followed by periods of large reversals / drawdowns,” Nomura’s Charlie McElligott wrote in his latest, before noting that “due to the pure magnitude of flows associated with [last week’s perceived ‘Reflation’ purge], many could be overstating or misinterpreting the ‘Hawkish Fed = Reflation Dead’ narrative rethink, risking a false optic that the trade is ‘done-and-dusted.'”
That’s what I’ve been attempting to communicate for a week straight. Charlie did a better job.
But if we were too quick to write the reflation trade’s obituary, it’s probably too soon to declare it “back.” Frankly, I’m not sure anyone feels totally comfortable “declaring” anything right now. Well, other than that people keep putting money into stocks.
“The inflows of money are still so good,” Morgan Stanley’s Mike Wilson said this week.
They sure are, Mike. Global equity funds have taken in nearly $600 billion YTD (see the latest flows update here).
And what’s not to like? The S&P is poised for its second-best first half in 23 years.
