U.S. stock markets had a challenging April, with the S&P 500 down 8.8%, bringing year to date losses to 13.31%.The speed with which markets dropped in April was a startling continuation of first-quarter weakness. Overall, the S&P 500 is on pace for its worst (inflation-adjusted) annual return since 1974.
Interestingly, this comes despite positive earnings reports: 80% of S&P 500 companies that reported by the end of April, beat expectations. However, tech companies were hit especially hard in the sell-off, with the Nasdaq logging its worst month since 2008.
The rout arguably began in the bond market, with U.S. Treasuries selling off (and yields moving higher) in anticipation of the Federal Reserve raising rates more rapidly than anticipated. Benchmark 10-year Treasuries traded at three-year highs in terms of rates (lows in terms of prices) towards the end of April.
Stocks and bonds sold off in tandem, which is a rare event, as we discussed in our latest flash report, and as a result, investors had few places to hide.
So, what’s driving volatility? In this article, we’ll cover some of the lingering effects of COVID-19 on global supply chains, the current inflation environment, and what the Federal Reserve is planning on doing to contain inflation.
While many of us have mostly returned to normal here at home, the COVID-19 omicron variant is still weighing on China. Due to a zero-tolerance policy, China has instituted lockdowns in numerous cities, including major hubs Shenzhen and Shanghai.
Manufacturing output is continuing, though logistical bottlenecks and shortage of transportation has prevented goods from flowing. Notably, port activity is at the lowest levels seen since the start of the pandemic, and inventories seem to be building. The concern is that this leads to another ripple effect and prolonged shortages of goods. Unfortunately, the expected length of the shutdowns and ensuing implications remain unclear.
Globally, it looks like supply chain shortages may have peaked in the fourth quarter of last year, as backlogs began to fall and delivery times improved. However in addition to Chinese lockdowns, the Russia-Ukraine war and new contract negotiations with U.S. West Coast dockworkers present additional stumbling blocks.
The road to completely eliminating supply chain issues is still ahead, but with continued improvement we could see an easing of some inflation pressures later this year. Markets are paying close attention to these inflationary pressures.
Supply chain disruptions, along with the horrific Russia-Ukraine war, create added uncertainty to already elevated consumer prices. At the risk of sounding like a broken record, inflation numbers are still hot, with an 8.5% increase for the year ending in March. Nearly a fifth of Americans now consider inflation to be the country’s most important problem, and spending increases aren’t limited to food and energy. There is concern that the Fed is on the verge of losing control of inflation, which is meant to be kept low and stable.
From walking back on the use of “transitory” in describing inflation to moving up the timeline for rate hikes, the Fed has been quickening its pace of policy moves. For context, last December they had projected a mere 0.75% in interest rate hikes this year. Stock markets took those projections in stride while expecting a slow, moderate path to higher rates.
Now the Fed projects an increase of 2.5% for all of 2022. However, the market is pricing in an even faster rate hike cycle.
The market believes these hikes will be front-loaded, pricing in expectations that the Fed will increase the Federal Funds Rate (the target interest rate they set) to the 2% to 2.25% range as early as July, which is earlier than previously anticipated. Just last month, the Fed’s forecast was for Fed Funds Rates to reach 2.75% by 2023. On May 4, the Fed confirmed a 0.5% increase.
What level is appropriate for the economy? Atlanta Federal Reserve President Raphael Bostic believes that the “neutral” Federal Funds Rate, where rates are neither supporting nor restricting growth, is between 2% and 2.5%. Given the strong labor market and hot inflation numbers, getting back to neutral seems like a fairly reasonable goal. Even so, the Fed seems to be rapidly adjusting to the environment, stoking fear that they’re a bit late on taming inflation.
Markets are pricing in a 0.5% rate hike at the May 3-4 FOMC meeting, followed by a 0.75% hike in June, a move not seen since the aggressive tightening cycle of 1994. Along with the market, we will be watching the Fed closely for any signs of changes.
External shocks like the Russia-Ukraine war and Chinese lockdowns seem to be prolonging concerns about inflation. Stocks and bonds are trading around year-to-date lows as markets anticipate faster tightening of financial conditions to fight rising prices.
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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.
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