Equity markets were up every day this week as small caps staged a huge breakout. Equities rallied into the Federal Open Market Committee (FOMC) meeting despite a cautionary tone from the bond markets. The initial reaction after the meeting was met with more equity buying and a rise in bond yields. The S&P 500 was up 2.4% this week and it was interesting to see both the NASDAQ and Russell 2000 outperform. The NASDAQ added 3.8% and the Russell 2000 blasted through its eight-month consolidation with a 6.8% gain. This propelled the Value Line Geometric Index, a proxy for the median stock, to also breakout to a new high.

The Employment Cost Index of Private Workers was up 4.6% versus the prior year, by far the largest in the 10-year series history. On the bright side, the ISM Manufacturing Index is still registering readings near 60 despite all kinds of evidence we are poised for a notable deceleration in the manufacturing cycle. If readings can stay sticky up at these levels, then the underlying strength of recovery is more robust than the message the bond market is sending. ISM Services came in way better than expected with a reading of 66.7, the highest reading in the 14-year series.

As expected, the FOMC announced the tapering of quantitative easing. They did not ease off on the timing, in what would be viewed as a dovish pivot, but rather accelerated the timing. Still, the embedded expectations were for hawkish comments that the Fed may be behind the curve on fighting inflation. No such comments were made, and the equity market took that as an all-clear. Aggressive bond positions were unwound with yields backing up on the day, although they are lower today and reversing yesterday’s action.

The result is that the Fed is now planning on having the balance sheet peak around $9 trillion, or double where they thought the last peak would be during the previous economic expansion. The entire Treasury curve has negative real rates for the first time ever. Core Personal Consumption Expenditures will likely be above 2% for 15 straight months by June of next year, which is expected to be the earliest that an increase in the federal funds rate would take place. Against this backdrop, somehow a hike in June is deemed hawkish by the bond market, whereas equities still see the pedal to the metal.

Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
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