Economic data will garner most of the attention next week, with investors placing a heavy weight on a host of reports as they try and determine the likelihood of a rate hike by the US Federal Reserve at its June meeting.
Multiple gauges of the manufacturing sector will be released along with durable goods orders, a reading on consumer sentiment and the revised gross domestic product report for the first quarter. Signs of improvement in the data would likely heighten expectations of a rate hike and put equities under pressure.
"These are some important data points and my sense is the investment community is in a 'good news is bad news' frame of mind right now," said Jack Ablin, chief investment officer at BMO Private Bank in Chicago. As recently as Monday, investors were nearly certain the central bank would hold off on an interest rate hike in June, as Fed funds futures rates showed only a 4-percent chance according to CME Group's FedWatch tool.
But the minutes from the Fed's April meeting, coupled with comments from New York Federal Reserve President William Dudley turned those expectations on their head, with expectations for a June hike standing at 30 percent on Friday.
"This week was really the week where the Fed pivoted, where the narrative changed," said Peter Kenny, senior market strategist at Global Markets Advisory Group in Berkeley Heights, New Jersey.
"The narrative changed from cautious, very cautious to something more constructive in terms of the economy."
The increased expectations could bring about a rotation in stocks rather than a broad decline in the S&P 500, however. With financials among the prime beneficiaries of a rate hike, that could spark them to take a leadership position after struggling for most of the year. That rotation would likely make sectors such as utilities, telecoms and real estate investment trusts (REITs) vulnerable.
That underperformance has made banks extremely cheap, with valuations on the S&P 500 bank index last month at their lowest relative to the overall index in more than 10 years, according to DataStream.
The S&P bank index has jumped nearly 4 percent this week and was on track to snap a 3-week losing streak on the prospect of higher rates helping to boost banks' earnings.
Sectors that have been attractive to investors in the low-rate environment, such as telecoms and utilities were both down more than 2 percent on the week, set for their worst week in five.
"We will see more of the rotation," said Scott Keifer, global investment specialist at JP Morgan Private Bank in Orange County, California.
"It is just the market pricing in and taking the complacency out of the thought the Fed is not going to move, that June is live."
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