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Hawkish Fed Surprise Upends the Markets

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U.S. equities were able to climb off their lows of the day, but stocks finished lower following a day full of data and surprising events. The midday tumble came courtesy of a surprise from the Fed following its policy meeting, where the central bank sharply increased its inflation expectations and pulled forward its forecast of when interest rates could begin to rise. Beforehand, investors sifted through another mixed bag of economic data that showed disappointing housing construction numbers, a rise in mortgage applications, and more data indicating a heat up in pricing pressures. Treasuries fell following the Fed meeting and the U.S. dollar finished solidly higher, while gold tumbled and crude oil prices were nearly flat. On the equity front, Oracle topped Q4 earnings estimates but offered disappointing Q1 guidance, General Motors upped its investment in electric vehicles, and Citigroup was the latest bank to warn of lower trading revenues in Q2. Markets in Europe and Asia finished mixed amid cautious trading ahead of the Fed's decision.

The Dow Jones Industrial Average declined 266 points (0.8%) to 34,034, the S&P 500 Index lost 23 points (0.5%) to 4,224, and the Nasdaq Composite shed 33 points (0.2%) to 14,040. In heavy volume, 1.1 billion shares were traded on the NYSE and 4.6 billion shares changed hands on the Nasdaq. WTI crude oil ticked $0.03 higher to $72.15 per barrel. Elsewhere, the Bloomberg gold spot price fell $27.82 to $1,831.20 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—jumped 0.7% to 91.17.

Oracle Corporation (ORCL $77) reported adjusted Q4 earnings-per-share (EPS) of $1.54, versus the $1.31 FactSet estimate, as revenues grew 8.0% year-over-year (y/y) to $11.2 billion, topping the Street's forecast of $11.0 billion. The company noted that its multi-billion dollar Fusion and NetSuite cloud applications businesses saw dramatic increases in their "already rapid revenue growth rates." However, ORCL issued fiscal Q1 EPS guidance that was below forecasts as it noted increased capital expenditures on its cloud businesses. Shares finished solidly lower. 

General Motors Company (GM $62) raised its first-half guidance for adjusted operating earnings and noted that it will boost its investments in electric vehicle (EV) and autonomous vehicle technologies from 2020 through 2025 to $35 billion, representing a 75% increase from its initial commitment announced prior to the pandemic. GM said it is targeting annual global EV sales of more than 1 million by 2025, and it is increasing its investment to scale faster because we see momentum building in the U.S. for electrification. Shares were higher.  

Citigroup Inc. (C $71) warned that Q2 trading revenue is likely to be down in the low 30% range and it sees U.S. consumer and investment banking to be down. C added that it expects loan loss reserves to be released in Q2 but less than in Q1. Shares were lower.

This is the latest bank to warn of a decline in trading revenue and you can check out our latest Schwab Sector Views: Downgrading Financials, in which we discuss how the sector still has many favorable attributes, but several red flags have emerged.

The Schwab Center for Financial Research (SCFR) offers our 2021 Mid-Year Market Outlook: Peak or Pause?. The SCFR notes that looking ahead to the second half of 2021, we think there are some notable market risks associated with the combination of peak economic/earnings growth rates, higher inflation, Federal Reserve policy and some stretched investor sentiment conditions.

Amid this backdrop, Schwab's Chief Investment Strategist Liz Ann Sonders discusses in her latest article, Turn Turn Turn: Rotations Persist, how it’s been a highly-rotational stock market this year in terms of leadership; with aggressively-speculative themes peppered in. Liz Ann cautions investors to remember that neither FOMO nor HODL are investment strategies.

Check out all our market commentary including our mid-year outlooks on the fixed income and global markets at our Market Insights page on and follow us on Twitter at @SchwabResearch.

Fed stands pat, but raises inflation expectations

The Federal Open Market Committee (FOMC) concluded its two-day monetary policy meeting today, opting to leave its stance and interest rates unchanged, as was widely anticipated, and there was also no change to its asset purchases. However, the Committee sharply raised its expectations for inflation this year and pulled forward the timeframe of when it could begin to raise interest rates, surprising the markets.

In its statement, the Committee said, "Progress on vaccinations has reduced the spread of COVID-19 in the United States. Amid this progress and strong policy support, indicators of economic activity and employment have strengthened." On inflation, it noted that prices have risen, but it still deems it as "transitory," while it also continued to reiterate its intentions to aim for an average of two percent over time, and that longerterm inflation expectations remain well anchored at two percent. However, in the updated economic projections provided with its statement, it upped its projection for PCE inflation to 3.4%, a full percentage point from its March estimate, and the core PCE, which excludes food and energy, to 3.0% from the previous meeting's 2.2% forecast. As well, the Committee increased its estimate for real GDP to 7.0%, a one-half percentage point above March's reading. As such, the Fed's "dots plot" showed that members saw a liftoff of rates could come as soon as 2023, whereas it saw no increases until at least 2024 at its last meeting.

In his scheduled press conference following the statement, Chairman Jerome Powell said that the effects of bottlenecks on inflation have been larger than anticipated, and that inflation could turn out to be higher and more persistent than previously thought. As such, Powell said that the Committee is prepared to adjust policy if pricing pressures move too high, but any needed change to its policy would remain accommodative. Get more in-depth analysis on the Fed's decision from Schwab's Liz Ann Sonders in here commentary later this afternoon on our Market Insights page.

Housing starts (chart) for May rose 3.6% month-over-month (m/m) to an annual pace of 1,572,000 units, below the Bloomberg consensus forecast of 1,630,000 units, and compared to April's downwardly-revised pace of 1,517,000 units. Building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, fell 3.0% m/m at an annual rate of 1,681,000, south of expectations calling for 1,730,000 units, and compared to the negatively-revised 1,733,000 unit pace in April.

The Import Price Index (chart) increased 1.1% m/m for May, compared to expectations calling for a match of April's upwardly-revised 0.8% increase. Versus last year, prices were up by 11.3%, compared to forecasts of a 10.9% increase and April's upwardly-adjusted 10.8% gain.

The MBA Mortgage Application Index rose by 4.2% last week, following the prior week's 3.1% decrease. The increase came as the Refinance Index gained 5.5% and the Purchase Index was 1.6% higher. The average 30-year mortgage rate declined 4 basis points (bps) to 3.11%.

Treasuries fell following the Fed's announcement, as the yield on the 2-year note rose 4 bps to 0.20%, the yield on the 10-year note jumped 8 bps to 1.57%, and the 30-year bond rate moved 2 bps higher to 2.20%.

Bond yields have shrugged off recent data showing hotter-than-expected inflation and Schwab's Chief Fixed Income Strategist Kathy Jones notes in her 2021 Mid-Year Outlook: Fixed Income, how we see the recent plateau in yields as a pause before the next wave higher given the economic and inflation risks we see for the second half of the year. Kathy also discusses in her article, Is 1970s-Style Inflation Coming Back?, that although we expect higher prices over the next few years, a return to that level of inflation is unlikely.  

The economic calendar for tomorrow will offer weekly initial jobless claims for the week ended June 12, with economists projecting that 360,000 first-time applications for unemployment were filed, as well as the Philly Fed Business Outlook Index for this month, expected to move lower to a level of 30.5 from May's 31.5, with a reading above zero denoting expansion in activity. The Leading Index for May will cap off the docket, forecasted to show an increase of 1.3% m/m following April's 1.6% rise.

Europe and Asia mixed ahead of Fed decision

European equities finished mixed, as the global markets seemed to tread cautiously ahead of today's monetary policy decision out of the U.S., which comes amid heightened concerns regarding inflation pressures. As such, the U.K. reported hotter-than-expected consumer price inflation statistics for May, preceding the stronger-than-expected U.S. import price inflation figures and following a host of mixed data out of Japan and China. The euro dipped versus the U.S. dollar and the British pound gained slight ground. Bond yields in the Eurozone and the U.K. traded lower. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, delivers his 2021 Mid-Year Outlook: Global Stocks and Economy, noting how the recovery is now over and a new global economic expansion has begun. He discusses how the new economic cycle has seen stock market leadership pass from the U.S. to Europe.

The U.K. FTSE 100 Index and France's CAC-40 Index were up 0.2%, Italy's FTSE MIB Index ticked 0.1% higher, Germany's DAX Index dipped 0.1%, Spain's IBEX 35 Index declined 0.3%, and Switzerland's Swiss Market Index traded 0.5% higher.

Stocks in Asia finished mixed as the markets remain choppy against the backdrop of festering inflation and monetary policy uncertainty, along with economic recovery optimism. The markets also digested a flood of economic reports in the region, while likely treading with some caution ahead of today's U.S. monetary policy decision. Schwab's Jeffrey Kleintop offers his article, Signs Inflation's Surge Is Transitory, noting while it's very early to say the rise in inflation has passed, there are signs that the fastest part of the rebound in inflation might soon be over. Jeff adds that raw material prices have pulled back from the highs of early May and supply chains for intermediate goods like semiconductors may be starting to improve. He concludes by noting that if these early signs continue to signal a deceleration of the upsurge in price pressures, market worries over inflation could begin to lessen.

Japanese data was in focus as the nation posted an acceleration in exports for May, which rose 49.6% y/y after April's 38.0% jump, but below expectations of a 50.8% gain. Also, the country's core machine orders—a gauge of capital investment—rose at a smaller rate than expected for April. India's exports rose 69.4% y/y in May but a deceleration from April's 195.7% surge. Just as the markets were getting set to close, China's May retail sales and industrial production both rose solidly but at paces that were below forecasts. Japan's Nikkei 225 Index declined 0.5% with the yen holding steady, and China's Shanghai Composite Index decreased 1.1%. The Hong Kong Hang Seng Index decreased 0.7% and India's S&P BSE Sensex 30 Index traded 0.5% lower. However, South Korea's Kospi Index increased 0.6% and Australia's S&P/ASX 200 Index ticked 0.1% higher.

The international economic calendar for tomorrow will hold employment figures from Australia, the trade balance from Italy and CPI from the Eurozone.

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