The Economy Remains Fundamentally Solid Despite Headwinds

Last week the focus was squarely on monetary policy, as the Federal Reserve met to consider when to begin winding down its bond buying program. And while it chose to put off the decision, it sent a clear message that is prepared to make such an announcement in November. Chairman Powell went so far as to say the Fed is targeting cessation of the program by the middle of next year if the economy progresses as anticipated. In addition, fully half of the meeting participants indicated that the first hike in the anticipated upcoming rate cycle could occur in 2022. Stocks rallied after the Fed meeting on Wednesday, reversing declines from earlier in the week on jitters related to credit issues in China and the breach of technical support the previous Friday. For the week, the S&P 500® index gained 0.5 percent, halting a two-week slide that took the index lower by 4.0 percent from its September 2nd high. Despite the slightly more hawkish policy outlook, investors took comfort in the Fed’s constructive view on both the economy and inflation. Intermediate bond yields climbed sharply as well. The yield on the ten-year Treasury note soared through resistance, climbing from 1.30 percent prior to the meeting to end the week at 1.45 percent. And, as this week gets underway, is trading at 1.48 percent, its highest level since late June.

Investor Sentiment Will be Tested this Week

Investors are understandably on edge as the trading week gets underway. The Fed meets this week and may have more to say about its tapering plans. The highly leveraged Chinese real estate market is raising concern of a more widespread economic crisis. And in the U.S., the S&P 500® index closed below its 50-day moving average last week, raising uncertainty whether stocks will once again find support at that level as has been the case throughout the year.

Investors Keeping a Close Eye on Fiscal Policy Changes

The stimulative federal policy regime that has been so supportive of the current bull market is evolving. The Federal Reserve is edging closer to beginning the process of removing monetary stimulus, while fiscal policy is edging closer to retargeting its focus. Taken together, these emerging developments are creating a degree of uncertainty, to the point where some market observers are warning of a period of higher volatility, and possibly an equity market correction. That such uncertainty is coinciding with a period of seasonal weakness historically makes such warnings all the more unsettling. Of course, whether markets respond unfavorably to these developments remains to be seen.

The Delta Variant Puts a Dent on the Pace of Economic Activity

The resurgent Delta variant of the coronavirus is putting a dent in the pace of economic activity, and that is complicating matters for the Federal Reserve. The economy generated just 235,000 new non-farm jobs in August. Including upward revisions to the prior two-month total, that was half as many jobs as expected, and well below the average of the previous three months.

Equities Reach New Highs on Economic Momentum

U.S. equities continued their surge higher, gaining 2.7 percent last week to close at another record high of 4128 on the S&P 500 Index. That brought the year-to-date rise to 9.9 percent, with almost 4 percent coming just since the start of April. Further evidence of gathering economic momentum came in the form of the ISM services sector report’s rise to a record high. The minutes from the Fed’s March meeting also provided some reassurance that monetary policy is likely to remain on hold for some time. Bond yields also contributed to the positive tone by easing slightly, as the ten-year yield fell 4 basis points to 1.66 percent. That is down from its recent peak of 1.74 at the end of March. High yield spreads also narrowed to their tightest in over two years last week. The dollar eased, and the VIX index declined to its lowest level in over a year.

Investors React to a Series of Changes from the New Administration

U.S. equities resumed their winning ways last week after a one-week hiatus, as the S&P 500® index gained 1.9 percent. Most of that gain came on Inauguration Day, after which the rally petered out as the new administration began to settle in. The index is now higher on the year by 2.3 percent. Both the dollar and the ten-year note yield were little changed on the week.