After posting a year to date high on Wednesday last week, the S&P 500 saw five consecutive down days and ended this week down over 1% as risk assets reflected anxiety in anticipation of the Brexit vote this week on June 23rd. The narrative last week was dominated by what turned out to be a somewhat surprising FOMC meeting and much speculation on both the outcome and implications of the looming British referendum.
Open market Brexit forecasts continue to differ from most poll results on the likelihood of a stay or remain vote. Polls showed a decisive shift early last week favoring the ‘leave’ camp, while open market (betting markets) saw a dramatic increase in the likelihood of a ‘stay’ outcome on the tragic news of an assassination of a British MP who was a vocal supporter of the stay movement. Over the course of the week, safe haven assets such as German Bunds, U.S. Treasury bonds, and gold rallied in response to the uncertainty. The yield on the 10yr U.S. Treasury touched its lowest intraday level since August 2012 of 1.52% before rebounding slightly to end the week. In a landmark occurrence, yields on the 10yr German Bund turned negative for the first time in history.
The FOMC meeting resulted in the Fed essentially capitulating to market forecasts by keeping interest rates steady and lowering their forward looking rate hike expectations. The Fed struck a much more dovish posture looking out over the next couple of years and is now expected to hike perhaps one time for the remainder of 2016 and lowered their rate hike expectations for the next two years. Notably, St. Louis Fed Governor James Bullard expects no hikes for the next two years. In a rare humble note from policy makers, the St. Louis Fed ceased publishing long-term rate estimates, citing the difficulty in accurately forecasting long-run rates.
Economic data last week was positive on balance as inflation sensitive categories all came in at or above expectations while activity surveys and housing data remained strong. Of note, median CPI is running +2.5% YoY and core CPI is firmly above 2% while unemployment remains very low at 4.7%. The Fed’s primary indicators are not signaling as much concern with inflation however as anemic business spending, a benign PCE, low commodity prices, and a lackluster manufacturing sector are providing them with a runway for a more dovish posture looking forward.
