Rudd’s MarketView for Wednesday, June 14, 2017

Summary

A slide in technology stocks pulled down the Nasdaq Composite on Wednesday and the S&P 500 ended slightly lower, as investors worried about the pace of economic growth after weaker-than-expected inflation numbers and an interest rate hike from the Federal Reserve.

The Nasdaq cut its loss in more than half in a late rebound, having earlier fallen 1 percent, while financials buoyed the Dow Jones Industrial Average.

The Fed cited continued economic growth and job market strength, proceeding with its first tightening cycle in more than a decade.

However, the Street worried about the Fed’s hawkish tone and that concerns about rate hikes were being reflected in the tech sector, which has led the S&P 500’s nearly 9-percent rally this year.

The tech sector fell 0.5 percent, recovering from steeper losses in the session and coming on the heels of its biggest two-day swoon in nearly a year. Tech remains up 18 percent in 2017.

Earlier on Wednesday, data indicated that consumer prices unexpectedly fell in May, while retail sales recorded their largest decline in 16 months.

Financials, which have underperformed this year and tend to benefit in a rising rate environment, rallied late to close up 0.2 percent. The group had fallen as much as 1.3 percent during the session.

The energy sector fell 1.8 percent as oil prices weakened. Data indicated an unexpectedly large weekly build in gasoline inventories, along with an International Energy Agency projection for a large increase in non-OPEC output in 2018.

The Fed clearly outlined a plan to reduce its $4.2-trillion portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession.

In corporate news, Alexion shares rose 9.3 percent making it the largest percentage gainer on the S&P 500 after the biotechnology company named Biogen’s chief financial officer as its CFO. Biogen’s stock fell 3.1 percent.

H & R Block rose 7.9 percent after the tax preparation service’s quarterly revenue and profit exceeded analysts’ expectations.

Approximately 7.1 billion shares changed hands on the major domestic equity exchanges, a number that was above the 6.8 billion share daily average over the last 20 sessions.

Fed Lifts Interest Rates

The Federal Reserve raised interest rates on Wednesday for the second time in three months and said it would begin cutting its holdings of bonds and other securities this year, signaling its confidence in a growing economy and strengthening job market.

In lifting its benchmark lending rate by a quarter percentage point to a target range of 1.00 percent to 1.25 percent and forecasting one more hike this year, the Fed seemed to largely brush off a recent run of mixed economic data.

The Fed’s rate-setting committee said the economy had continued to strengthen, job gains remained solid and indicated it viewed a recent softness in inflation as largely transitory.

The Fed also gave a first clear outline on its plan to reduce its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession.

It expects to begin the normalization of its balance sheet this year, gradually ramping up the pace. The plan, which would feature halting reinvestments of ever-larger amounts of maturing securities, did not specify the overall size of the reduction.

“What I can tell you is that we anticipate reducing reserve balances and our overall balance sheet to levels appreciably below those seen in recent years but larger than before the financial crisis,” Fed Chair Janet Yellen said in a press conference following the release of the Fed’s policy statement.

She added that the balance sheet normalization could be put into effect “relatively soon.”

The initial cap for the reduction of the Fed’s Treasuries holdings would be set at $6 billion per month, increasing by $6 billion increments every three months over a 12-month period until it reached $30 billion per month.

For agency debt and mortgage-backed securities, the cap will be $4 billion per month initially, rising by $4 billion at quarterly intervals over a year until it reached $20 billion per month.

Fed policymakers also released their latest set of quarterly economic forecasts, which showed only temporary concern about inflation and continued confidence about economic growth in the coming years.

They forecast economic growth of 2.2 percent in 2017, an increase from the previous projection in March. Inflation was expected to be at 1.7 percent by the end of this year, down from the 1.9 percent previously forecast.

A retreat in inflation over the past two months has caused jitters that the shortfall, if sustained, could alter the pace of future rate hikes. But the Fed maintained its forecast for three rate hikes next year.

The Fed’s preferred measure of underlying inflation has retreated to 1.5 percent, from 1.8 percent earlier this year, and has run below the central bank’s 2 percent target for more than five years.

Earlier on Wednesday, the Labor Department reported consumer prices unexpectedly fell in May, the second drop in three months.

Yellen indicated the Fed remained confident inflation would rise to its target over the medium term, bolstered by what she described as a robust labor market that is continuing to strengthen.

The Fed’s estimates for the unemployment rate by the end of this year moved down to 4.3 percent, the current level, and to 4.2 percent in 2018, indicating the Fed believes the labor market will continue to tighten.

The median estimate of the long-run neutral rate, which is seen as the level of monetary policy that neither boosts nor slows the economy, was unchanged at 3.0 percent.

Minneapolis Fed President Neel Kashkari dissented in Wednesday’s decision.

Consumer Price Index and Retail Sales Both Down

Consumer prices unexpectedly fell in May and retail sales recorded their biggest drop in 16 months, suggesting a softening in domestic demand that could limit the Federal Reserve’s ability to continue raising interest rates this year.

The Labor Department indicated Wednesday morning that its Consumer Price Index fell 0.1 percent last month, weighed down by declining prices for gasoline, apparel, airline fares, motor vehicles, communication and medical care services, among others.

The second drop in the CPI in three months followed a 0.2 percent rise in April. In the 12 months through May, the CPI rose 1.9 percent, the smallest increase since last November, after advancing 2.2 percent in April.

The year-on-year gain in the CPI in May was still larger than the 1.6 percent average annual increase over the past 10 years.

The so-called core CPI, which strips out food and energy costs, rose 0.1 percent in May after a similar gain in April as rents continued to increase moderately. The core CPI increased 1.7 percent year-on-year, the smallest rise since May 2015, after advancing 1.9 percent in April.

The Fed has a 2 percent inflation target and tracks an inflation measure which is currently at 1.5 percent. The Fed said on Wednesday it expected annual inflation rates to “remain somewhat” below 2 percent in the near term but stabilize around the central bank’s target over the medium term. Chair Janet Yellen said they were monitoring inflation developments closely.

The Fed hiked its benchmark overnight interest rate by 25 basis points to range of 1.00 percent to 1.25 percent, and said it would start reducing its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities this year.

In a separate report, the Commerce Department said retail sales fell 0.3 percent last month amid declining purchases of motor vehicles and discretionary spending after a 0.4 percent increase in April. May’s drop was the largest since January 2016 and confounded economists’ expectations for a 0.1 percent gain.

Retail sales rose 3.8 percent in May on a year-on-year basis. While some of the drop in monthly retail sales reflected lower gasoline prices, which weighed on receipts at service stations, sales at electronics and appliance stores recorded their biggest decline since March 2010.

Excluding automobiles, gasoline, building materials and foodservices, retail sales were unchanged last month after an upwardly revised 0.6 percent rise in April. These so-called core retail sales correspond most closely with the consumer spending component of gross domestic product and were previously reported to have increased 0.2 percent in April.

Consumer spending accounts for more than two-thirds of the U.S. economy. Despite last month’s weak core retail sales reading, low inflation could translate into higher consumer spending in the calculation of GDP.

The economy grew at a 1.2 percent annualized rate in the first quarter, held back by a near stall in consumer spending and a slower pace of inventory investment.

Output increased at a 2.1 percent pace in the October-December period. The Atlanta Fed is forecasting GDP rising at a 3.2 percent annualized rate in the second quarter.

Please visit Rudd International on our other social media pages:

YouTube link: https://www.youtube.com/channel/UCsfYOwF6MqrEVrZLKBfZscA

Facebook: https://www.facebook.com/ruddinternational/

Twitter: https://twitter.com/ruddintl

Website: http://ruddinternational.com