Last Week in Review – December 16, 2022

Last Week In Review

Fears over rising interest rates pushed the S&P 500 Index lower for a second consecutive week and to levels last seen in early November. Nearly every sector within the index recorded sharp losses, except for energy shares, which were supported by a partial rebound in oil prices. Roughly USD 4 trillion expiration in options contracts on Friday sparked additional volatility. Trading in exchange-traded funds (ETFs) reached near-record levels at midweek, indicative of investors moving in and out of stocks in response to broader economic signals.

Last week the two highly anticipated announcements appeared to send sentiment in opposite directions—much higher at the start of the week and sharply lower at its end. The first was the release of the consumer price index (CPI) before trading began on Tuesday. The data showed that headline inflation rose only 0.1% in November from October, bringing the year-over-year gain to 7.1%. That is still well above the Federal Reserve’s long-term 2% inflation target, but the lowest level since December 2021. Core (less food and energy) inflation rose 0.2%, a tick below consensus expectations and driven mainly by housing costs are already showing signs of cooling.

Many investors assumed that the good news on inflation would notably impact Fed policy. Still, the release of the December policy meeting statement on Wednesday afternoon, followed by Fed Chair Jerome Powell’s press conference, sent stocks sharply lower. While, as widely expected, the Fed slowed its pace of rate increases by announcing a 50-basis-point (0.50 percentage point) increase in the federal funds target rate—the four previous meetings each brought rate increases of 75 basis points (0.75 percentage point)—the official statement reiterated that ongoing rate increases are likely.

Major stock indexes tumbled over 1% within seconds of the release, perhaps as investors flipped to the quarterly summary of individual policymakers’ economic projections, which showed that the median forecast for the federal funds rate in 2023 rose to 5.1%, well above the 4.6% officials had anticipated in September. Fed Chair Powell did little to calm fears at his press conference, stressing the need for further rate hikes and the inflationary dangers of a tight labor market, which has proved resilient despite the Fed’s aggressive rate hikes this year. On Thursday, similar rate moves and commentary from European central banks further darkened investors’ moods.

US – Markets & Economy

The other notable surprise of the week may have been Thursday’s data on retail sales, which dropped 0.6% in November, defying expectations for a slight increase and indicating a disappointing post-Thanksgiving “Black Friday” and “Cyber Monday” sales season. Sales in the previous two months were also revised lower.

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

U.S. Treasury yields decreased, with a more pronounced move in shorter-maturity notes. The broad tax-exempt bond market traded modestly higher over most of the week but did not keep pace with the rally in Treasuries. (Bond prices and yields move in opposite directions.) According to our traders, the week’s light supply calendar helped to counter continued outflows from municipal bond funds industrywide.

Traders I spoke to noted that investment-grade (IG) corporate bonds performed well in the wake of the softer-than-expected CPI print. Yankee banks (with significant U.S. operations but domiciled elsewhere) and riskier bonds outpaced higher-quality securities. The IG market’s reaction to the Fed meeting was relatively quiet. New issuance was subdued, and traders expect a muted primary calendar through year-end.

The lower-than-expected CPI print boosted the high-yield bond market, but the Fed meeting weighed on sentiment. Again, traders I spoke with noted that they expect liquidity in the below-investment-grade market to become more challenged as we move toward year-end. In the bank loan market, they stated that retail sellers raised cash due to negative flows from the asset class.

US Treasury Markets – Current Rate and Bi-Monthly Change

Interesting News Overseas

Shares in Europe fell sharply after central banks indicated that interest rates would likely need to rise further and for longer than markets previously hoped. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 3.28% lower. Major stock indexes also weakened. Germany’s DAX Index dropped 3.32%, France’s CAC 40 Index lost 3.37%, and Italy’s FTSE MIB Index slid 2.43%. The UK’s FTSE 100 Index gave up 1.93%.

The European Central Bank (ECB) raised its key interest rate by 0.5 percentage points to 2%. Although the increase was less than the three-quarter-point hike implemented at the two previous meetings, ECB President Christine Lagarde said rates “will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive” to bring inflation back down to the central bank’s 2% target. The ECB also said it plans to shrink the portfolio accumulated as part of its Asset Purchase Program by an average of EUR 15 billion per month, starting next March and running through the end of the second quarter.

The downturn in eurozone business activity continued for a sixth consecutive month in December, according to preliminary results from a survey of purchasing managers. S&P Global’s flash composite purchasing managers’ index (PMI) ticked up to 48.8—a reading still in contractionary territory (below 50) but exceeded a consensus forecast for 48.0 in a Reuters survey of economists.

The Bank of England (BoE) hiked its key interest rate by 0.5 percentage points—the ninth consecutive increase—to a 14-year high of 3.5%. The Monetary Policy Committee, which voted 6–3 in favor of the move, said “further increases” may be required to quell inflation. In a letter to finance minister Jeremy Hunt, Governor Andrew Bailey noted that UK inflation may have peaked. The BoE also forecasted that the economy would shrink 0.1% in the year’s final quarter, less than its November estimate, which had called for a 0.3% contraction.

Japan’s stock markets fell over the week, with the Nikkei 225 Index declining 1.34% and the broader TOPIX Index down 0.58%. Risk appetite suffered as the U.S. Federal Reserve (Fed) presented a more hawkish than anticipated monetary policy outlook, and concerns grew that continued tightening by the major central banks could push the global economy into recession. Japan’s government finalized its tax revision package, while the latest PMI data highlighted the divergence between an expanding services sector and a shrinking manufacturing sector.

The yield on the 10-year Japanese government bond (JGB) was broadly unchanged from the prior week at 0.25%, continuing to hover around the level at which the Bank of Japan (BoJ) implicitly caps JGB yields, amid ongoing speculation that the central bank could abandon its policy of yield curve control as early as next year. The BoJ is widely expected to leave its monetary policy settings unchanged at its December 19–20 meeting. The yen weakened to around JPY 137.1 against the U.S. dollar, from about 136.5 the previous week, coming under pressure from the Fed’s hawkish stance.

Lastly, in China, stocks fell as weaker-than-expected economic data dampened investor sentiment. The Shanghai Composite Index was down 1.22%, and the blue-chip CSI 300 Index declined 1.1%, reversing several weeks of gains. Vice Premier Liu He indicated that Beijing is considering new measures to support the real estate industry lifted property sector stocks.

A trio of key economic indicators for November was weaker than expected as pandemic-related disruptions weighed on activity. Industrial production rose 2.2% in November from a year earlier, marking the softest growth since May, while retail sales declined by 5.9%. Fixed asset investment for the year through November also missed forecasts.

Although China recently lifted some of its more onerous coronavirus restrictions, its economic reopening is expected to be bumpy. Recent reports have noted that economic activity remains depressed as concerns about the virus’s spread have discouraged people from resuming their normal activities. In contrast, rising infections have left many businesses facing labor shortages.

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