Commentary provided by Mark Szycher, Vice President, Investment Specialist, AIG Retirement Services
Market Performance Snapshot* (Week ending June 17, 2022 and year-to-date)
- Dow Jones Industrial Average®: -4.8% | -17.8%
- S&P 500® Index: -5.8% | -22.9%
- NASDAQ Composite® Index: -4.8% | -31.0%
- Russell 2000® Index: -7.5% | -25.8%
- 10-year U.S. Treasury note yield: 3.24%
- Up 8 basis points from 3.16% on June 10, 2022
- Up 173 basis points from 1.51% on December 31, 2021
- Best-performing S&P 500 sector this week: Consumer staples, -4.4%
- Weakest-performing S&P 500 sector this week: Energy, -17.2%
*Past performance is no guarantee of future results.
Stocks fall, yields experience volatility as Fed hikes 75 basis points
Equities dropped sharply and Treasury yields made steep moves up and down as aggressive Fed rate-hiking led investors to reassess equity valuations and reinforced recession concerns. The S&P 500 Index endured its worst weekly performance in more than two years. All S&P 500 sectors fell at least 4.4% with energy suffering the steepest fall as U.S. oil prices dropped more than 8% on recession concerns, among other factors.
- On Wednesday, the Federal Open Market Committee (FOMC) raised the federal funds target rate by 75 basis points to a range of 1.5-1.75%, the largest rate increase at a single meeting since 1994. The vote was 10-1, with Kansas City Fed president Esther George preferring a 50 basis point increase.
- As late as the previous Friday, markets had been expecting a 50 basis point increase based on comments from Fed officials in the weeks leading up to the meeting. However, after the most recent Consumer Price Index reading, the University of Michigan consumer sentiment report, and the Federal Reserve Bank of New York’s Survey of Consumer Expectations, speculation grew that the Fed would act more aggressively to tamp down longer-term inflation expectations.
- As markets shifted their rate hike forecasts prior to the Fed’s announcement from 50 basis points to 75 basis points, Treasury yields jumped. On Tuesday, the 10-year yield closed at 3.48% and the 2-year yield closed at 3.42%, their highest closing levels since 2011 and 2007, respectively. The yield curve flattened, often considered a harbinger of recession. After the announcement, some investors saw buying opportunities in bonds, sending yields (which move inversely to prices) down more than 20 basis points, though remaining near multi-year highs.
- The whipsaw movements in yields may indicate a wide dispersion of investor sentiment as to whether the Fed will succeed in taming inflation without sending the economy into a tailspin or if a sharp but perhaps brief recession is a bitter but necessary pill.
- Higher yields and recession fears weighed heavily on stocks. On Monday, the S&P 500 entered a bear market, having closed 22% below its record closing high on January 3, 2022. Stocks dipped again on Tuesday but recovered a bit on Wednesday, remaining stable after the Fed’s decision was announced. Indices turned negative again on Thursday and were mixed on Friday as recession fears again dominated the market narrative.
- European stocks also fell as central banks raised rates. Facing high inflation and slowing growth, the Bank of England raised its benchmark rate by 25 basis points to 1.25%—the fifth consecutive increase—and pledged to “act forcefully in response” to “indications of more persistent inflationary pressures.” The Swiss National Bank unexpectedly raised its policy rate by 50 basis points, the first increase since 2007, though the rate remains negative (-0.25%).
Fed sees slower growth, higher rates ahead
In addition to the FOMC’s rate decision, the Fed issued its latest Summary of Economic Projections, which showed higher expectations for inflation and the target federal funds rate and lower expectations for U.S. GDP growth versus the last forecast issued in March.
- The median projection for Personal Consumption Expenditures (PCE) inflation in 2022 is now 5.2% vs. March’s forecast of 4.3%. Inflation next year is expected to decline to 2.6%, little changed from the March projection. That figure would still be above the Fed’s 2% target and is predicated on the Fed and external forces turning the tide on inflation.
- GDP is expected to grow 1.7% this year vs. March’s forecast of 2.8%. The unemployment rate is expected to be 3.7% at the end of 2022 vs. 3.5% projected in March.
- The median projection for the federal funds rate is now 3.4% by the end of 2022—if realized, double the now-current rate—and 3.8% by the end of 2023. That is substantially higher than March’s projection of 1.9% by the end of this year and 2.8% by the end of 2023.
- In his post-meeting press conference, Fed chair Jay Powell addressed the apparent change of view leading to a 75 basis point hike by pointing to recent reports showing inflation running hot and consumers’ inflation expectations rising. In particular, Powell called June’s University of Michigan consumer sentiment index, which showed 5-year inflation expectations rising from 3% to 3.3%, “quite eye-catching,” adding, “We’re absolutely determined to keep [inflation expectations] anchored at 2%.”
- While acknowledging “today’s 75-basis-point increase is an unusually large one, and I do not expect moves of this size to be common,” Powell indicated another could be in the offing for July: “From the perspective of today, either a 50 basis point or a 75 basis point increase seems most likely at our next meeting. We will, however, make our decisions meeting by meeting and we’ll continue to communicate our thinking as clearly as we can.”
- Powell confirmed that the Fed wants the federal funds rate to go “up to restrictive levels, which would be …somewhere in the range of 3 to 3.5% by year end.” However he also made clear the Fed is “not trying to induce a recession now.”
- With regard to whether the economy can avoid recession despite the Fed’s rate hikes, Powell said, “Our objective really is to bring inflation down to 2% while the labor market remains strong. I think what’s becoming more clear is that many factors that we don’t control are going to play a very significant role in deciding whether that’s possible or not. And there I’m thinking, of course, of commodity prices, the war in Ukraine, supply things like that … It’s not getting easier. It’s getting more challenging because of these external forces.”
- When will the Fed’s goals be met? Powell said he wants to see “a series of declining monthly readings for inflation” constituting, “convincing evidence, compelling evidence, that inflation is coming down.” On the labor front, “the labor market we had before the pandemic … that’s what we want to get back to.”
- Despite lower forecasts for GDP growth this year, Powell was still upbeat on the economy overall: “There’s no sign of a broader slowdown that I can see in the economy. People are talking about it a lot. Consumer confidence is very low. That’s probably related to gas prices and also just stock prices, to some extent, for other people. But … we’re not seeing a broad slowdown. We see job growth slowing, but it’s still at quite robust levels. We see the economy slowing a bit, but still growth levels—healthy growth levels.”
Economic reports show high inflation, rising inflation expectations, and slower sales
Data released during the week indicated firmly entrenched inflation and rising inflation expectations, which may be affecting consumer spending patterns, as well as growing concerns about overall business and economic conditions.
- The latest Producer Price Index (PPI)—measuring prices along the supply chain before they reach consumers—registered a monthly gain of 0.8% in May, in line with consensus forecasts but double April’s 0.4% rise and half of March’s 1.6% gain. May’s PPI was 10.8% higher than a year ago, equaling forecasts.
- Goods inflation (+1.4% month over month) outpaced services inflation (+0.4%), with energy prices (considered a form of goods) rising 5% during the month. Excluding energy, food, and trade services, core PPI rose 0.5% for the month and 6.8% for the year.
- The New York Fed’s Survey of Consumer Expectations found one-year inflation expectations rising to 6.6% in May from 6.3% in April. Expectations for inflation three years from now remained at 3.9%—well above the Fed’s 2% target.
- The New York Fed survey noted, “Perceptions about households’ current financial situations deteriorated noticeably in May with more respondents reporting they are financially worse off today than a year ago. Year-ahead expectations about households’ financial situations also deteriorated in May, with more respondents expecting to be worse off a year from now than they are today.”
- The Commerce Department reported May’s retail sales—not adjusted for inflation—fell 0.3%, below forecasts for a 0.1% gain. Spending on gasoline rose 4% while spending on vehicles and parts fell 3.5%. Removing those factors, other retail sales gained 0.1%. Spending at restaurants and bars increased 0.7% as the shift toward spending on entertainment and services continued, while spending at grocery stores grew 1.2%, possibly reflecting higher prices.
- The National Federation of Independent Business’s Small Business Optimism Index for May found just 23% of small business owners expect better economic conditions in the next six months vs. 77% who don’t. The net -54% is the lowest reading in the 48-year history of the survey.
- A net 72% of respondents reported raising their selling prices, matching March’s record high. Fifty-one percent reported job openings that couldn’t be filled, up from 47% in April.
- The National Association of Home Builders/Wells Fargo Housing Market Index for June remained firmly in positive territory but fell to its lowest level since June 2020. At 67 (readings above 50 are considered positive) the figure is well below the 90 level of late 2020. It was the sixth straight monthly decline, which the NAHB’s chairman called “a clear sign of a slowing housing market in a high-inflation, slow-growth economic environment.”
Final thoughts for investors
As Fed chair Jay Powell said in his press conference, “This is a highly uncertain environment—extraordinarily uncertain environment.” With so many questions continuing to swirl around inflation, supply chains, geopolitical developments, and more, expect continued volatility and speak with a financial professional about staying focused on long-term goals.
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