Investors Prepare for the Fed’s Widely Expected Tapering Announcement

This is central bank week. On Wednesday, the Fed is widely expected to announce the start of tapering its bond buying program. The groundwork has long been done to prepare markets for this move in hopes of avoiding any disorderly response. Treasury yields have shifted higher recently, but mostly in response to rising inflationary pressures that cast some doubt on its supposedly transitory nature. At its September meeting, half of the participants projected possibly one interest rate hike by the end of 2022, with the median Fed funds forecast ending the year at 0.3 percent. That forecast also projected core PCE inflation to end 2022 at a rate of 2.3 percent, down from 3.7 percent at the end of this year. Since then, however, investors have brought forward an expectation of at least two quarter-point rate hikes by the end of 2022, as inflation concerns have intensified. The Treasury yield curve has flattened noticeably, falling from 121 basis points at the start of October to 108 currently. During that time, the two-year note has climbed from 0.29 to 0.50 percent, while the ten-year move has been more muted, rising from 1.49 to 1.58 percent.

Last week, it was reported that the September core PCE deflator rose by 3.6 percent year-over-year in September. That pace is certainly well above the Fed's longer-term target of around 2.0 percent. But September's pace continued a string of five straight months of relative moderation in the measure's trajectory. After starting the year at 1.5 percent, core PCE inflation stood at 3.5 percent. That has been followed by four straight months at 3.6 percent. Nevertheless, the stickiness of supply-chain disruption, rising labor costs, and higher prices for energy have swelled the ranks of those becoming increasingly skeptical that inflation will recede as the Fed expects.

Shorter-term bond yields have climbed in global markets as well. The Bank of England also meets this week, and could raise its benchmark rate. The Reserve Bank of Australia also meets against a backdrop of sharply rising yields. And investors in the Eurozone have pushed back against the ECB's forecast of no rate hikes next year. Last week, the Bank of Canada announced the end of its bond buying program, keeping its benchmark rate unchanged.

Equity Markets Take Economic News in Stride and Hit Another Record High

Equity markets have, so far, taken all of this in stride. In the U.S., the S&P 500^® index ended the week at another record high at 4605, as investors have maintained their focus on solid third quarter earnings. And this closing record high came on Friday after Apple and Amazon, together accounting for 10 percent of the S&P 500's market cap, both sold off following disappointing third quarter earnings. It also came on a day when the employment cost index rose at a record pace in the third quarter, and one day after the advance estimate of third quarter GDP fell well short of even lowered expectations at a pace of just 2.0 percent. The S&P 500 delivered a 6.9 percent gain in October, a welcome turnaround from September's 4.8 percent decline. Factset reports that with more than half of S&P 500 results having already been reported, third quarter earnings are rising at a projected pace of 37 percent, up 10 percent from what was expected at the end of the quarter. Roughly an additional one-third of the S&P 500 is scheduled to report earnings this week.

Eurozone Equities Enjoy Their Own Resurgence; Investors Await this Week's Jobs Report

Although not quite at a record high, Eurozone equities have enjoyed their own October resurgence after a difficult September. The EuroStoxx 50 index climbed 1.5 percent in euro terms, leaving it higher for the month by 5.0 percent, after a September drop of 3.5 percent. Last week, the Eurozone reported estimated third quarter growth at an annualized pace of 9.1 percent, dwarfing the experience of the U.S. for dollar-based investors, however, these results have been trimmed by a strengthened dollar. Versus the dollar, the euro has slid from 1.181 at the start of September to 1.156 at the end of last week.

Also on this week's economic calendar in the U.S. is the October jobs report. It is expected to show a gain of 450,000 new jobs, with the unemployment rate falling to 4.7 percent. How influential this report will be in terms of policy is questionable, however, since on Wednesday the Fed will likely have already tipped its hand.

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