Central banks around the world, including the Federal Reserve (Fed), are focused on fighting inflation by raising interest rates and reducing accommodation. Stock and bond markets alike are repricing in order to understand this new monetary policy regime.
- Growth concerns –Financial conditions have already become more restrictive, but markets are reacting to how growth may slow if interest rates continue to climb. The world is dealing with a pandemic, supply shortages, and a major geopolitical conflict, so central banks’ battle with inflation just adds another source of uncertainty for markets. However, the U.S. economy remains in good shape as consumers, corporations, and municipalities are not over leveraged. Our base case remains that a near-term recession is unlikely.
- Stock markets –Last week, global stock markets dropped due to fears around slowing growth. The S&P 500 was down over 5% at one point, before recovering on Friday. Year to date, the S&P 500 is down 15.1%. This has come from a contraction in valuations, or P/E ratios, instead of earnings expectations falling. Higher interest rates paired with high inflation are causing investors to question valuations.
- Bond markets –The reaction to high inflation and the Fed reducing accommodation was for bond yields to rise to start the year. As inflation fears turned to growth fears last week, bonds became a safe haven as yields dropped and prices increased. The 10-year U.S. Treasury yield dropped by 0.19% last week. Our view is the tug-of-war between bond buyers seeking protection and bond sellers worried about inflation will continue to cause high volatility throughout the rest of the year.
A look back
- After an intra-week drawdown of over 5%, the S&P 500 recovered almost half of its losses on Friday, relieved by Chair Powell’s reaffirmation that the Fed is not currently entertaining 75 basis point hikes.
- U.S. yields ended the week lower across the curve amid elevated volatility. The 10-year Treasury yield ended the week at 2.93%, down 19 basis points.
- The Consumer Price Index slowed modestly in April to 8.3% year over year, a 0.2% drop from March’s 40-year high. However, the deceleration was smaller than expected.
A look ahead
- Analysts will watch this week’s regional factory and retail sales activity in an effort to gauge the effect rampant inflation is having on new orders and consumer demand.
- Several Fed officials will make public appearances and provide insights to the central bank’s efforts to achieve a soft economic landing.
- Economic releases: Initial Jobless Claims, Retail Sales, Industrial Production, MBA Mortgage Applications., Housing Starts, Existing Home Sales, the Leading Index, and Empire Manufacturing.