The FOMC meeting and its aftermath dominated the newsflow last week. As expected, there were no changes to the Fed Funds rate, and no specific indications as to when the Fed may begin to taper its asset purchase programs. However, changes to the “dot plot” (the annual rate forecasts from Fed policymakers) were interpreted by the market as a hawkish signal, as was confirmation from Fed Chair Jerome Powell that FOMC members were at least beginning to discuss the prospect of tapering.
Market participants collectively concluded that a rate hiking cycle may begin sooner than previously expected, and longer term inflation expectations fell. The result was a significant rotation trade away from cyclicals, commodities, and small/mid cap equities, all of which stood to benefit from stronger near-term growth, and towards assets that benefit from lower long-term inflation assumptions, including technology stocks and long-dated bonds.
As a result of these changes in assumptions, the Nasdaq outperformed the Dow by more than 3%, while small and midcap indices had their worst week of 2021. Meanwhile, the Treasury yield curve flattened significantly: 2y yields rose to 25bp (their highest level in more than a year), 10y yields were very close to unchanged, and 30y yields fell 13bp to 2.01% (their lowest level since February). This flattening was especially hard on bank stocks, which fell more than 8% on average last week after peaking in early June.