Comments by the Fed indicate it will not hike key rate for a long time
On June 22 Jerome Powell, chairman of the Federal Reserve, told financial markets that a US key interest rate hike will not occur until well into the future, even though the Fed will begin discussions on how it should phase out quantitative easing (QE). He repeated that the Fed expects US inflation to fall again next year. Powell’s statement was followed on June 23 by more hawkish comments from two non-voting regional Fed presidents, Raphael Bostic and Robert Kaplan, who indicated that the key rate should be raised by late 2022 and that tapering of the Fed’s bond purchases should start sooner rather than later.
Preliminary purchasing managers’ indices for June
Last week’s IHS Markit PMIs were largely somewhat stronger than expected, with the US manufacturing sector setting a new record high. European PMI figures were also high. In June, Germany’s Ifo business climate indicator rose 2.6% from the previous month to its highest level since 2018, as Europe’s largest economy rebounded after the relaxation of COVID-19 restrictions. Business sentiment figures did not generate any major financial market movements, since they were largely in line with expectations.
Government crisis in Sweden
Swedish headlines are dominated by the government crisis and efforts to form a new governing coalition after Stefan Löfven resigned as prime minister on June 28. His centre-left minority government will remain in office in a caretaker role while the speaker of Parliament gives successive party leaders a chance to assemble a new government that Parliament will approve or at least tolerate. Swedish markets are continuing to react calmly to the political crisis, and movements have been largely non-existent. The krona lost ground on June 28 and is now trading at what we consider a weak SEK 10.15 or so per euro.
As usual after the end of a month, the coming week will offer a lot of new macroeconomic data. Highlights include US employment data for June, which will be published this coming Friday, July 2. On July 1, Sweden’s Riksbank will announce its monetary policy decision.
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Our market view
Temporary stock market turbulence due to worries about key rate hikes
The US Federal Reserve calmed financial markets on June 22 after a discussion about future key interest rate hikes led to temporary stock market worries. US share prices are again at or near record highs, fuelled by signals of strong economic growth – along with continued low interest rates and bond yields. But recent market developments show that worries about significantly higher interest rates and yields would undoubtedly generate market headwinds – especially if yields rise to levels that make bond investments an attractive alternative to equities. But it will take a while to get there. And what happens instead when investors become worried about the stock market outlook and move money into bonds is that this triggers a decline in yields (= bond prices rise). Ten-year US Treasury yields have fallen from the 1.6-1.7% range to below 1.5%. In Sweden and elsewhere in Europe, government bond yields remain at extremely low levels.
As the economic recovery accelerates during the next few quarters, it will be reasonable if bond yields climb. Major central banks are unlikely to raise their key interest rates before 2023 at the earliest. We believe that 10-year US Treasury yields may climb above 2% during 2022, a development that is widely expected. This will probably also be acceptable to investors − without causing major stock market reactions − since the upturn in yields will not be large or alarmingly rapid.
A sharper upturn in yields than we are forecasting might be triggered by persistently high inflation. Right now we are experiencing higher inflation than for a long time, but there are many indications that this surge is temporary and that inflation will again fall to the vicinity of central bank targets.
Inflation worries are offset by other, powerful forces that favour stronger stock market performance. Listed companies have made it through a few tough quarters with earnings that surpassed market expectations. Now that economic growth is taking off in earnest, corporate earnings should do the same. Consensus forecasts point to nearly 40% higher earnings for global listed companies this year. This will provide solid support to share prices.
In the past week or so, growth stocks have regained their pace-setting role – benefiting from low interest rates and yields, which boost the present value of their future earnings. We also expect that many of the trends that favour this type of companies, especially digitisation and automation, will continue to generate good potential for expansion. Large and increasing spending on sustainability, especially in the environmental field, also indicates that this type of investments will not only be good for the planet but also for portfolio performance, at least in the long run.
Shaky stock markets after rapid upturns are fairly typical. Renewed worries about inflation, bond yields and interest rates – or ominous new signals related to the pandemic and COVID mutations − are among factors that may trigger such market turbulence. But good fundamentals, including strong economic growth and continued low interest rates and yields, should help maintain dynamic stock markets. Because of somewhat stretched valuations, however, future upturns do not have the same potential as those of the past year.