What should we expect from the Federal Reserve on Wednesday, June 16, 2021?

The June 16, 2021 FOMC meeting results may be one of the last big event risks before summer trading conditions firmly set in.


Chairman Powell & the Fed are widely expected to leave monetary policy unchanged tomorrow. They are also likely to assert that inflation is “transitory” and play down taper talk. Nonetheless, markets will be looking for hints on whether the Fed is starting to acknowledge that inflation could potentially be sticky (wage increases, housing, etc.). Any hint that the Federal Reserve is more cautious or is even “thinking about thinking about tapering” could result in a risk-off tone and a widening of treasury yields.


As discussed in our prior note on inflation, as Treasury yields widen, longer duration asset classes like growth stocks and tech, along with stocks that do not have pricing power could see lower prices, as investors rotate out of them. As discount rates rise, assets with the highest growth rates and terminal values are usually the most sensitive.


Background

Over the last couple weeks, Treasury yields actually tightened for 2 reasons, which helped reflate longer duration risk assets, like U.S. small-cap growth and tech stocks:


1) May nonfarm payrolls surprised to the downside dramatically (reported June 4)

  • Payrolls came in at +559,000 vs. expectations of >675,000

  • The market now understands that Federal unemployment assistance through Sept. 2021 continues to disincentivize workers from joining the labor force until the fall

  • U.S. job market is still 7.6 million short of pre-pandemic levels as a result

  • This was dovish, because of the Federal Reserve’s focus on lowering unemployment

2) Biden’s infrastructure plan will be downsized dramatically, putting less pressure on fiscal deficit

  • Biden originally proposed a $2.3 trillion infrastructure and economic recovery plan

  • Talks with Republicans collapsed amid disagreements on what to include in the bill and how to pay for it in May

  • 10 bipartisan senators tried to win support for a smaller $1 trillion deal and failed at that as well

  • Less U.S. spending on infrastructure, means a lower deficit and slower increase in the country’s debt burden

These two catalysts caused massive short covering in the Treasury market, as many institutions were short bonds in May (see graph below).


Since then, two inflation metrics, the CPI (consumer price index) and PPI (producer price index) both came in above expectations, while retail sales today missed expectations. This put upward pressure on rates again, given the perception that higher inflation was putting pressure on consumer spending.


The PPI of 6.6% y/y that came out today was higher than last month’s 6.2%, and was the highest print in the index’s history, since the index was started in 2010.


You can see the time series below:



So what is next? The Federal Reserve has commenced its 2-day meeting today, which concludes tomorrow. Interpretations of the minutes from these minutes will be VERY important.


How are we thinking about different outcomes? The 2nd half of this piece will cover the following related topics:


Topics Covered:

• What are the Federal Reserve minutes going to say tomorrow?

• How are Federal Reserve governors thinking about inflation?

• How is the Fed thinking about jobs data?

• Is early “tapering” possible?

• When could we potentially see a rate hike? Has the dot-plot likely changed?

• Repercussions for liquidity and the Fed’s reverse repo volume?

• FX: How could this affect the USD?


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