Small Companies Rally Before Fed Meeting

Small Companies Rally Before Fed Meeting

As Fed officials meet to determine the short-term direction of monetary policy, they have newly-released evidence to mull over that shows inflation beginning to accelerate at long last.



Small Companies Rally Before Fed Meeting
Small Companies Rally Before Fed Meeting

The May Consumer Price Index, a key measure of inflation, climbed 0.4% in May, more than the consensus expectation which had called for just 0.2%, and a faster pace of price increases than the 0.3% seen in April. Excluding the more volatile components of food and energy, the increase was a still-brisk 0.3%. Looking at the change year-on-year, the CPI was up 2.1% at the headline level and 1.9% at the core level.

While the Fed is unlikely to be substantially swayed by just one month of data, the fact remains that April’s CPI already showed signs of warming inflation and May now hints at a trend, albeit one that seems to clash with cooling prices at the wholesale level as indicated by last Friday’s Producer Price Index. Today’s report will give some ammunition to those at the two-day FOMC meeting with a hawkish stance but, nevertheless, the committee is unlikely to deviate from its well-established pattern of cutting back on its monthly asset purchases by $10 billion per meeting.

Should inflation continue to rise, it would create a tricky situation for the Fed though. Despite long months of steady progress, the labor market remains in need of a helping hand and for several years the Fed has been able to maintain an extremely dovish position without the encumbrance of worrying about inflationary pressures. Indeed, the persistently low level of inflation has in itself been a justification for stimulus. With an annual change of 2.1% in CPI, inflation has now returned to target and the Fed can no longer be so unfettered in its accommodation. It will be very interesting to see, therefore, if there is any hint in the language of the Fed’s statement of a hawkish bias being adopted.

The forex market’s reaction to the surprisingly warm inflation data has been dollar buying, with the currency strengthening against all its major peers. EUR/USD dropped 0.20% to 1.3546, while AUD/USD plummeted 0.66% to 0.9339. The Aussie dollar was also affected by the release of the minutes from the June 3 Reserve Bank of Australia meeting, at which the benchmark interest rate was maintained at 2.5%. The minutes revealed the RBA’s board expects GDP to grow at a below-trend rate ‘over the next year or so’, with inflation projected to stay within target, with the conclusion that ‘the current accommodative stance of policy was likely to be appropriate for some time yet.’

Housing data was also released today, in the form of housing starts for May. The report showed a 6.5% drop month-on-month, falling to a seasonally-adjusted, annualized rate of 1.001 million units from 1.071 million in April. This muddies the water somewhat after yesterday’s evidence of bullish sentiment amongst home builders, leaving a level of uncertainty over how much we can expect housing to contribute to the economy in the second quarter.

The stock market has risen in the main today, but it remains another quiet day with no clear trend. By early afternoon in New York, the Dow Jones Industrial Average was up just 0.07% at 16,793, while the broader S&P 500 index climbed 0.14% to 1940.6. The subdued price fluctuations we have seen so far this week could be shaken up with the Fed decision on Wednesday afternoon, which certainly has the potential to inject a greater amount of volatility into the market. 


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