In light of the heightened market volatility brought on ever since last week’s hotter than expected May y/y CPI report, it was widely expected that the Fed would finally try to get ahead of the inflation train, rather than continually attempt to play catch up. As such, all talk of a possible 25 bp rate hike for the June meeting was thrown out of the window, replaced instead with expectations for a hike of 50 bp-75 bp. As was announced yesterday afternoon by Fed Chair Powell, a 75 bp rate hike increased the targeted Fed Funds rate to the range of 1.25%-1.75%. Note as well that though late, this was the first 75bp rate hike since 1994 and signals that the Fed is serious about combatting inflation. Powell’s further comments that for the next meeting (July 27/28), an additional rate hike of 50 bp -75 bp “seems more likely” was taken positively by the markets.
Fast forward to the very next day (June 16), the Bank of England announced a 25 bp rate increase while the Swiss National Bank surprised with a 50 bp hike (representing the first rate hike since 2007!). The Swiss rate hike is ever more poignant seeing as that country has for decades battled a strengthening Swiss Franc environment. These additional central bank moves clearly signal that the environment of rising rates and inflation is going to be a reality for a much longer period than initially expected (remember terms such as transitory or nearing peak inflation ?). The end of cheap money since 2010 is essentially here and with this newfound understanding comes increasing fears of economic slowdowns and recession. After the Fed statement the spread between 30yr and 10yr Treasury yields inverted for the first time since 2006, suggesting slower growth for a long time. Accordingly, global markets took another leg lower today in recognition of this deeply entrenched new reality.
Physical Gold Futures: GC=F
Yields on the 10-Year Treasury: TNX
Dollar Index: DXY
Euro Futures: 6E=F
Swiss Franc Futures: 6S=F
GBP Pound Futures: 6B=F
Yen Futures: 6J=F
CAD Dollar Futures: 6C=F
S&P 500: GSPC
Yields on the 10yr Treasury have doubled YTD from 1.66% to 3.34% while the DXY has increased by 8.0%. Gold futures have remained predominantly flat at +1.2% YTD while equities have been pummeled as the S&P has dropped by 20.5%. Within equities, the Energy sector has had (by far) the highest YTD return at nearly +50%. Incredibly at a forward P/E of 9.7x, the Energy sector is still among the cheapest (while also having the highest dividend yield at 3.1%), followed by Financials at 11.2x (average dividend yield of 2.4%) and Materials at 12.9x (average dividend yield of 1.9%). For context, the S&P currently trades at a forward P/E of 15.2%. Dating back to 2014, the correlations are as follows: