Following a rocky start to the year, turbulence roiled markets in May. As stocks tumbled, the S&P 500 stock market index briefly entered bear market territory, which is when stocks drop more than 20% from a recent peak. After data showed signs of slowing inflation, the S&P 500 rallied to end nearly flat for the month. The bounce finally ended a seven-week losing streak for both the S&P 500 and tech-heavy Nasdaq.
By the end of the month, Treasury yields were generally lower (higher bond prices) amid softer economic data and signs of peaking inflation. If inflation is finally slowing down, then the Federal Reserve may not have to hike rates as quickly as anticipated, which would be welcomed by markets.
In this month’s newsletter, we’ll discuss global slowdown concerns and Fed policy, consumer sentiment, and a looming Russia debt default.
As the Russia-Ukraine war continues to disrupt commodity prices and the Fed hikes rates to tackle inflation, concerns over global economic growth are growing. There is also risk in China, where a two-month lockdown in the financial hub of Shanghai is finally easing. Now, the government is tasked with trying to revive a sharp slowdown in the Chinese economy. Both the sagging Chinese economy and logistical bottlenecks have a negative spillover effect on the rest of the world.
With all that in mind, a Bloomberg survey of economists now puts the odds of a U.S. recession within the next year at 30%. It’s not a foregone conclusion, but the risk is there, and market-watchers will be monitoring it closely.
It’s hard to make a trip to the grocery store or gas station without experiencing some sticker shock. Perhaps not surprisingly, U.S. consumer sentiment fell to a new decade low on the back of soaring inflation and a bit of pessimism about buying conditions.
Retail stalwarts such as Walmart, Target, and Costco posted weaker-than-expected earnings and warned of mounting costs, pushing equity markets lower. As cost pressures accumulate, retailers are seeing changes in consumer behavior. For example, Walmart noted on its earnings call that customers are switching brands and choosing lower-margin groceries as they feel the pinch. Demand, however, remains robust as consumers dip into savings to spend, and, again, there are signs that inflation is tapering.
Largely as expected, the Fed hiked rates another 50 basis points (0.5%) in May in an effort to stem inflation. Risks of higher prices still remain, but the Fed seems to favor a less aggressive approach than the markets expected. In a dovish surprise, Fed Chair Jerome Powell noted that a 75 basis point (0.75%) rate hike was not being ‘actively considered’.
Besides rates, the market is also paying attention to quantitative tightening (QT), a process that essentially decreases the money supply in the economy and which will begin in June. The scale of unwinding will be nearly twice as fast as the previous market cycle. However, it is also expected to be done quite predictably as the Fed allows its balance sheet to “run-off” naturally (i.e., let bonds that it owns expire).
The main takeaway is that the Fed remains committed to unwinding stimulus while evaluating ongoing economic data to determine its timing. The Fed is trying to engineer a soft landing, but there’s a strong chance the process will be bumpy for investors.
As the Russia-Ukraine war continues into its third month, the West continues to hope that its sanctions can pressure Russia to end the war. The U.S. is pushing Russia towards a historic debt default after the U.S. Treasury Department declined to extend a key sanctions waiver that had allowed Moscow to keep paying bondholders interest.
As of May 25th, U.S. banks and individuals were effectively barred from accepting bond payments from Russia. Russia actually has the funds and a 30-day grace period from May 27th, but U.S. banks will not be allowed to process payment to bondholders. This would likely trigger the first default by Russia in over a century. Forcing Moscow into a default would tarnish Russia’s reputation in financial markets, with potentially significant long-run consequences for the country.
When asked about the economic impact, Treasury Secretary Janet Yellen downplayed its effects, saying that Russia is “already cut off from global capital markets, and that would continue.” This is a highly unprecedented move that we’ll be watching, with hopes that it can bring a faster close to the war.
The Fed’s May meeting minutes point to successive 50 basis point (0.5%) rate hikes in June and July. While a larger rate hike seems to be off the table for now, markets will react if there are any further changes in expectations. At this point, market “dip” buyers are hoping that the Fed has reached peak hawkishness, though the looming war in Russia and Ukraine could still have unintended consequences. We’ll be watching key economic data while bracing for potential market volatility.
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The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Nasdaq Composite is a market-capitalization- weighted index consisting of all Nasdaq Stock Exchange listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds or debenture securities. The Bloomberg Barclays U.S. Aggregate Bond Index measures the investment-grade U.S. dollar-denominated, fixed-rate taxable bond market and includes Treasury securities, government-related securities, corporate securities, residential and commercial mortgage-backed securities, and asset-backed securities.
The S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally considered representative of the broad U.S. stock market. The MSCI All Country World Index (ACWI) is designed to represent the performance of large- and mid-cap stocks across 23 developed and 26 emerging markets and represents approximately 85% of the free float-adjusted market capitalization of each market. The MSCI Europe Index captures large- and mid-cap representation across 15 developed market countries in Europe and covers approximately 85% of the free float-adjusted market capitalization across the European developed market equity universe. The MSCI Emerging Markets Index captures large- and mid-cap representation across 26 emerging market countries and covers approximately 85% of the free float-adjusted market capitalization in each country.