Next week brings a new element of uncertainty to the US stock market.
US equities continued their upward trajectory last week, buoyed by hopes for a potential peace agreement between the US and Iran and a strong debut for SpaceX shares boosting market sentiment. It is noteworthy that recent market movements have become more volatile, and next week introduces a potential new source of uncertainty: the first Federal Open Market Committee (FOMC) meeting under new Chair Wash. Some investors are concerned that a premature interest rate hike to combat inflation could dampen enthusiasm for risk assets.
Fed Rate Hike Pressure Moderates
This week saw the release of several key economic data points, with the monthly inflation report being the most closely watched. The US Consumer Price Index (CPI) for May rose 0.5% month-over-month and 4.2% year-over-year, both figures aligning with market expectations. The year-over-year increase accelerated from the previous month's 3.8%, reaching its highest level since April 2023. Core CPI, which excludes food and energy, increased 0.2% month-over-month, below the expected 0.3%, and was up 2.9% year-over-year, slightly higher than the previous month's 2.8%.
As a key gauge of upstream costs, the US Producer Price Index (PPI) for May rose 1.1% month-over-month, exceeding the consensus forecast of 0.7%. Year-over-year, it surged 6.5%, marking the largest increase since November 2022. Core PPI increased 0.4% month-over-month, below the 0.5% expectation, with a corresponding year-over-year rise of 4.9%, significantly lower than the market's 5.4% forecast.
Data from the University of Michigan's Consumer Sentiment Survey showed the index recovering to 48.9 this month from a historic low of 44.8 in May. The survey indicated consumers' one-year inflation expectations edged down to 4.6% from 4.8% in May, though this level remains elevated. Their five-year inflation expectation fell to 3.4% from 3.9% the previous month.
Senior economist Bob Schwartz commented that the recent decline in oil prices has contributed to a slight improvement in consumer confidence, but the American public remains generally concerned about the economic outlook. High energy costs erode real disposable income, forcing households to cut back on spending. If inflation expectations remain anchored, the Federal Reserve may view the inflationary impact from this oil price shock as a temporary, one-off event.
US Treasury yields fell across the curve this week, primarily due to developments in the Middle East and the subsequent drop in oil prices. The policy-sensitive 2-year Treasury yield fell approximately 8 basis points over the week to 4.085%. The benchmark 10-year yield declined around 5 basis points to 4.487%, and the 30-year yield retreated below the key psychological level of 5%.
According to the CME FedWatch Tool, markets widely anticipate the Fed will hold rates steady in June and July. The probability of a 25-basis-point hike in September, October, and December has decreased compared to a week ago. Market pricing now suggests the first meeting where a rate hike probability reaches 100% has been pushed back from the previously anticipated December FOMC meeting to March 2027.
Schwartz stated that he expects the Fed to hold rates steady at its meeting next week, while removing dovish language from its policy statement and eliminating projections for rate cuts this year from its accompanying dot plot. He believes that the recent improvement in the overall labor market and heightened short-term inflation risks have temporarily given the upper hand to hawkish views. "New Fed Chair Wash will likely guide the Committee to consider a range of factors, acknowledging these risks while also weighing the trajectory of services inflation and the disinflationary effects from productivity gains."
Can the Rally Sustain Its Momentum?
US stocks advanced across the board this week with most sectors posting gains. According to Dow Jones Market Data, the Materials sector led the gains, rising 3%, followed by Consumer Staples (+2.6%) and Financials (+2%). Only two sectors declined: Communication Services and Energy. Meta Platforms Inc and Alphabet Inc, the parent company of Google, fell 4.4% and 2.4% this week respectively, leading the declines in the Communication Services sector.
Data from LSEG Lipper shows that US equity funds experienced net outflows of $12.57 billion for the week, the first weekly net redemption since May 20, influenced by volatility in chip stocks and concerns over Fed policy. During the week, US large-cap funds saw net outflows of $10.2 billion, while mid-cap and small-cap funds had net outflows of $1 billion and $2.22 billion, respectively.
The strategy team at Bank of America warns that the risk of a near-term market top is rising. Led by Savita Subramanian, the team cautions that the current rally has triggered 70% of typical bear market warning signals. In particular, the outperformance of high-P/E stocks over low-P/E stocks is a classic sign of excessive speculation, and investors should be on high alert. "The risk warning lights are flashing, suggesting the S&P 500 and technology stocks may be entering a corrective phase."
In its market commentary, Charles Schwab noted that while the major indices finished the week higher overall, they experienced significant intraday swings. Apple Inc hosted its annual Worldwide Developers Conference (WWDC) on Monday, but the event ultimately fell short of investor expectations. The closely watched semiconductor sector was volatile throughout the week but still managed a cumulative gain of approximately 9%, finding support once again at its 20-day moving average.
Looking ahead to next week, the firm expects bulls to maintain an advantage with an overall bullish bias. Key risk factors include renewed turbulence in the Middle East and the possibility of the Federal Reserve delivering a more hawkish message than anticipated.
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