The Week Ahead – Life in the Vax Lane

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

On March 4 2020, Governor Newsom took decisive action by declaring a state of emergency. More than a year later, nearly all of the state mandated Covid restrictions have now been rolled back, allowing the nation’s most populous state to lift most of its pandemic safety protocols. That means capacity restrictions on businesses, as well as physical distancing requirements, have been relaxed. If the business allows it, you can go to a bar and sit at a stool right next to a stranger. You can go to a packed movie theater. You can go dancing at a club, sing at church, and go to a Lakers game. I went to one of my favorite restaurants last Thursday with a good friend. It was surreal to see the establishment full of people without masks, smiling and having fun – it felt normal – it felt great! Thanks to the miracle of human ingenuity and science, the vaccines have successfully turned the tide on Covid-19, and the numbers continue to move in the right direction.

As goes the battle against the pandemic, so goes the global economy. Despite the economy firing on all cylinders, interest rates continue to remain surprisingly low. Indeed, the Atlanta Reserve Bank GDPNow model is forecasting annual economic growth rate of a whopping 10.3% for the second quarter. After corporate earnings surpassed expectations by the widest margin since 1994, we are expecting another quarter of surprisingly strong earnings growth for Q2 – nearly twice that of last year. This dissonance between ultra-low interest rates and a robust economic backdrop is almost certainly being caused by the Federal Reserve continuing to buy $120 billion of U.S. bonds each month.

Last Wednesday we saw a rather strong market reaction to the Federal Reserve moving forward rate hike expectations from 2024 to the second half of 2023. Keep in mind, that is still almost two and half years from now. Financial conditions will remain at historically easy levels for a long time to come. Still any time the Fed tilts towards hawkishness, we should expect a short-term spike in volatility. I would expect the Fed to course correct with dovish rhetoric over the next couple of months. Of course, given the rapid pace of economic rebound, the Federal Reserve will necessarily reduce monetary stimulus, but that means continued monetary support – just at a reduced level. Additionally, it is important to keep in mind there are many offsets to the Fed’s eventual wind-down of bond purchases (quantitative easing): historic amount of domestic savings ($5 trillion), pent-up demand, the positive impact of surging Consumer Net Worth, economic momentum, and the ongoing global economic re-opening.

Housing and personal income are the key economic indicators to pay attention to this week. We estimate the monthly home price index likely surged over +2.0% in April. Home demand remains high while inventory is at near historic lows. Existing and new home sales probably slipped in May. Durable goods orders likely rebounded above consensus. The Purchase Managers Index for June is expected to remain in expansion territory – another sign of economic strength. Personal income probably fell in May as transfer payments dropped sharply. Finally, inflation pressures continue to be an issue as demand continues to outstrip supply – PCE deflators are expected to remain elevated in the near-term.

Data deck for June 21–June 25: