Last Week in Review, May 20, 2022

Last Week In Review

Last week continued the equity markets weekly losing streak as fears grew that inflation was causing consumers to pull back on discretionary spending, setting the stage for a coming recession. At its low point last Friday, the S&P 500 Index was down roughly 20.9% from its January intraday high, exceeding the 20% threshold for a bear market and placing it back at levels last seen in February 2021. On Wednesday, the index’s biggest decline came when it suffered its biggest daily loss since June 2020. However, traders I spoke with noted that market activity was surprisingly subdued, with trading volumes more than 10% below recent 20-day averages and below every day of the previous week.

Disappointing earnings and revenue results from several of the nation’s major retailers appeared to spill over into negative broader sentiment. Most dramatically, shares in Target fell roughly 25% after earnings fell short of estimates by nearly a third, which the company attributed to a combination of reduced sales of discretionary items, such as televisions, and higher costs. Results from Walmart, Lowe’s, and Home Depot also fell short of expectations—while Costco shares may have tumbled in part on rumors that it was raising the price of its popular café hot dog (not that!). Aside from the hit to profit margins, investors seemed to worry that major retailers would be forced to pass on more of their higher input costs to customers in the coming months, keeping inflation elevated

US – Markets & Economy

Comments last week from Federal Reserve officials did little to calm inflation and interest rate fears. On Wednesday, Fed Chair Jerome Powell told The Wall Street Journal that taming inflation was an “unconditional need” and that policymakers wouldn’t hesitate to raise rates as much as necessary, even if it meant “some pain [was] involved.” On Thursday, Kansas City Fed President Esther George acknowledged the “rough week” in equity markets on CNBC. Still, she seemed to welcome it as “one of the avenues through which tighter financial conditions will emerge.”

Last week’s economic data offered mixed signals about whether a recession was imminent, and Wall Street’s reaction to the data was also arguably hard to decipher. On Tuesday, investors welcomed the news that retail sales, excluding the volatile auto segment, had risen more than expected in April (0.6% versus roughly 0.4%), while March’s gain was revised upward to 2.1%. Industrial production, manufacturing production, and capacity utilization figures in April also surprised on the upside.

On Thursday, however, a gauge of manufacturing activity in the Mid-Atlantic region fell short of expectations by a wide margin, and weekly jobless claims rose more than expected. Housing starts and existing home sales also came in lower than expected, reflecting the pressure from higher mortgage rates. However, traders noted that the downside surprises sparked brief rallies in stock prices, perhaps because they drove a sharp decline in longer-term interest rate expectations.

US – Equity Market Performance

SOURCE: BLOOMBERG. THIS CHART IS FOR ILLUSTRATIVE PURPOSES ONLY AND DOES NOT REPRESENT THE PERFORMANCE OF ANY SPECIFIC SECURITY. PAST PERFORMANCE CANNOT GUARANTEE FUTURE RESULTS.

US Yields & Bonds

The yield on the benchmark 10-year U.S. Treasury note fell as low as 2.77% in intraday trading last Thursday, its lowest level in nearly a month. (Bond prices and yields move in opposite directions.) The broad tax-exempt bond market registered negative returns and underperformed U.S. Treasuries through most of the week. However, on Thursday, municipal bond portfolio managers observed more constructive market conditions as yields partly retraced their early-week increase. General obligation debt offerings from New York City and the state of Illinois were met with solid demand, providing further signs of stabilization in the muni market.

Investment-grade corporate bonds weakened as an active primary calendar weighed on market technicals. Also, the earnings miss from some prominent retailers resulted in growing fundamental concerns across the market. Despite these concerns, newly issued bonds performed well in general as attractive concessions bolstered investor demand.

Conversely, high yield bond performance marginally improved early in the week as the earnings season progressed. However, the market later retraced the gains with CCC-rated names faring worse than higher-quality bonds. Traders I spoke with noted that the recent acceleration of outflows contributed to the unwinding of the significant inflows the asset class experienced in 2020, while the primary market remained quiet with minimal issuance.

Traders also reported that the recent volatility in the bank loan market subsided as the week began, which led to a few new deal announcements. They also noted increased demand from bank buyers as recent paydowns resulted in elevated cash balances. However, the hawkish Fed commentary fostered broad risk-off sentiment.

US Treasury Markets – Current Rate and Weekly Change

Interesting News Overseas

Last week shares in Europe pulled back amid fears of slowing economic growth and faster interest rate increases. The pan-European STOXX Europe 600 Index slipped 0.55% in local currency terms. Germany’s Xetra DAX Index dropped 0.33%, France’s CAC 40 Index lost 1.22%, and the UK’s FTSE 100 Index gave up 0.24%. Italy’s FTSE MIB Index, on the other hand, advanced modestly.

Core eurozone government bond yields, fluctuated, ending roughly unchanged. Hawkish signals from several European Central Bank (ECB) officials caused yields to rise early in the week. For example, ECB Governing Council member Klaas Knot appeared to suggest the possibility of a 50-basis-point interest rate increase in July. Yields subsequently pulled back as weak retail earnings in the U.S. worsened fears of an economic slowdown. Peripheral euro zone bond yields, which broadly tracked core markets over the week, ended slightly higher. UK gilt yields rose on inflation reaching its highest level in 40 years, better-than-expected employment data, and hawkish comments from Bank of England Chief Economist Huw Pill.

The latest macro data provided more evidence that the UK economy may be on the brink of stagnation. According to the Office for National Statistics, inflation accelerated in April to the highest level since 1982, hitting 9.0% on surging electricity and gas prices. The unemployment rate in the three months ended March 31 fell to 3.7%—the lowest level since 1974—with job vacancies exceeding the number of jobless for the first time on record. Weekly earnings growth (including bonuses) rose by 7.0% sequentially.

Meanwhile, retail sales volumes in April unexpectedly increased 1.4% month over month. However, a survey conducted by research company GfK showed that UK consumer confidence dropped to its lowest level in nearly 50 years in May.

Japan’s stock market returns were positive for the week, with the Nikkei 225 Index gaining 1.18% and the broader TOPIX index up 0.71%. Toward the end of the week, the regional sentiment was boosted by China’s action to support its property sector, the latest in a series of monetary easing measures to boost the economy weighed down by coronavirus lockdowns. Japan’s government announced that the country’s strict border control measures would be reduced further and also lent some support. Against this backdrop, the yield on the 10-year Japanese government bond fell to 0.23% from 0.24% at the end of the previous week, while the yen strengthened to around JPY 127.98 against the U.S. dollar, from about JPY 129.27 the prior week.

Japan’s economic recovery lagged that of its global peers, with its GDP contracting by an annualized 1% quarter on quarter during the first three months of 2022. Factors behind the contraction included deteriorating trade as import prices soared and sluggish consumer spending due to the coronavirus restrictions that had been in place. The Bank of Japan (BoJ) has repeatedly said that it will continue with its massive monetary stimulus to support the post-pandemic recovery—the relatively weak GDP data are likely to reinforce this stance. In April, inflation exceeded the BoJ’s 2.0% target as the core consumer price index rose 2.1% from a year earlier. However, consumer price pressures remained far weaker in Japan than elsewhere globally, also supporting the case for continued easing.

Separate data showed that Japan’s exports rose 12.5% year on year in April, led by U.S.-bound shipments of cars, while shipments to China fell sharply as the economic slowdown caused by the country’s coronavirus lockdowns weighed on demand. Imports increased by 28.2% after energy prices soared due to the war in Ukraine.

Lastly, Chinese stocks rose as the central bank cut interest rates to support the country’s flagging property sector, even as disappointing economic data weighed on sentiment. The broad, capitalization-weighted Shanghai Composite Index advanced 2.0%, and the blue-chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, climbed 2.2%.

On May 13th, the People’s Bank of China (PBOC) cut the five-year loan prime rate (LPR), a reference for home mortgages, by an unexpectedly large 15 basis points to 4.45%. That rate cut came after the central bank cut the lower limit of mortgage rates for first-time homebuyers the previous Sunday. The PBOC’s rate cuts followed data showing a plunge in home sales in April. (China’s five-year and one-year LPRs are based on interest rates that 18 banks offer to their best customers. Banks use the five-year LPR to price mortgages, while most other loans are based on the one-year rate.)

The reduction in the five-year LPR signals that China’s government is trying to bolster homebuying demand. Given that the rate cut was done at a national rather than a regional level, they added that the PBOC’s move is more significant. Local-level rate cuts have failed to spur much demand after China’s government has stepped up efforts to regulate the housing market in recent years, which has affected how people view housing as an investment. China’s policymakers are trying to balance supporting first-time homebuyers, discouraging speculation, and not offering relief to developers.

Economic data released last week pointed to slowing growth. For April, retail sales and industrial output data lagged estimates amid continued pandemic lockdowns reflecting China’s zero-COVID approach. Fixed asset investment rose 6.8% from January to April a year ago but also missed the consensus forecast. In April, home prices in China fell for the eighth straight month, declining 0.3% from March, marking the fastest decline in five months.

China’s 10-year government bond yield edged up to 2.836% from 2.834% a week ago. The yuan firmed to 6.68 from 6.80 per U.S. dollar in currency trading. The International Monetary Fund said it increased the yuan’s weighting in the Special Drawing Rights (SDR) currency basket following its first review of the SDR since China joined the basket in 2016. The SDR is an international reserve asset made up of five global reserve currencies (the U.S. dollar, euro, yuan, yen, and British pound).

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