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The predominant theme in the second quarter was inflationary pressure in the financial markets, and how this might impact the Federal Reserve’s policy decisions on interest rates. The inflation rate in May was 5% compared with a year earlier. Year-on Year price increases in almost all commodities have been very elevated, evidenced by the copper market (+51%), wheat (up 21%), US median home prices (up 23%), and oil (up over 50% this year).

The Federal Reserve believes that this inflation is transitory, and appears elevated due to the “look-back” effect, i.e., the fact that the basis of comparison was so low last March, April, and May.

In June, the Fed raised its expectations for headline inflation to 3.4%, a full percentage point higher than its forecast in March. The Fed brought forward the timeline to when they might raise interest rates to 2023.

Interestingly, the bond market seems to agree. Economists were expecting the ten-year bond yield to surpass 2% due to inflationary pressures, while they have done quite the opposite. In the first quarter, ten-year bond yields soared from 0.9% to 1.75%, but have subsequently come back down to 1.25%, despite concerns over inflation and a gradual removal of Fed stimulus. This would almost imply a near-recessionary growth pattern next year. The Federal Reserve’s June meeting minutes showed some concern over downside risks to the economy justifying ultra-low interest rates and continued asset purchases. Earlier this week saw mixed economic data, especially a bigger-than-expected drop in the ISM services index

The outlook for the second half of the year appears to be more defensive, as investors worry over the prospect of less monetary and fiscal support, the likelihood of higher taxes, inflationary expectations (be they transitory or permanent), The Delta Covid variant, and good growth numbers looking less favorable going forward due to the base effect. Certainly “quantitative easing” looks as if it is heading toward a conclusion as the Fed takes its foot off the accelerator. Another source of concern is the effect on consumer spending when unemployment benefits run out in September.

Unemployment is now at 5.9%, and the economy added an astounding 850,000 in June, led by the leisure/hospitality sector, retail trade, and the government sector. Many employers are now finding it difficult to meet rising demand for goods and services. Manufacturing is being particularly affected by this, as qualified workers become scarce. As a result, companies are raising wages to attract workers. Amazon, Walmart, Costco, McDonald’s, and Chipotle have all increased wages. Bank of America has increased its minimum wage from $20 to $25 per hour. Having said that, there are still 3.68 million more unemployed right now than in pre-Covid February 2020.

Another important theme in second quarter was increasing tension between China and the West. As the 100-year anniversary of the Chinese Communist party came and went on July 1^st, belligerent rhetoric concerning Taiwan from Xi Jinping is rising. Now that the historic milestone has occurred, expect more issues with Chinese economic growth and global divestment out of China. There are 244 Chinese companies that are listed on a U.S. stock exchange, most of which are listed as American Depository receipts. These ADR’s are regulated by the US Public Company Accounting Oversight Board and have a combined market capitalization of around $2 trillion. Beijing is tightening restrictions on overseas listings of Chinese companies at a time when global interest in these companies is declining for both geopolitical and economic reasons. Chinese government probes, especially into technology companies, are making China less attractive to other parts of the world. Meanwhile, Chinese retail sales, industrial production, fixed-asset investment, and property investment are missing estimates, and the Chinese Purchasing Manager’s Index is edging down in recent months.

The Biden Infrastructure spending bill is looking likely to pass through the Congress in the near future, though perhaps in a somewhat reduced form, initially. The bill would represent the largest investment in transportation, water systems, and services since FDR’s New Deal in the 1930’s. 90% of the jobs generated by the spending would be aimed at workers without college degrees.

While Covid concerns are waning in the United States, the appearance of the delta variant is a source of concern to investors s the rest of the worlds seeks to cope with it. Mary Daly, the President of the San Francisco Fed, announced this week that the delta variant poses a threat to world economic recovery.

The S&P 500 index was up 14.4% in the first quarter, the Nasdaq gained 12.5% and the Dow Industrial Index gained 12.7%.