Last Week in Review – January 14, 2022

Last week the large-cap indexes recorded their second consecutive weekly loss to start the year—and the technology-heavy Nasdaq Composite its third—as the unofficial start of earnings season began. Financials shares came under pressure on Friday as JPMorgan Chase and Citigroup, typically among the first major companies to release results, reported lower profits in the fourth quarter. Utilities, real estate, and health care shares were also weak within the S&P 500 Index. Energy shares outperformed as oil prices continued their climb back to late-October highs. On several desks, traders I spoke with noted that technical factors, such as inflows from retail investors, drove some of the week’s volatility.

Inflation signals and concerns about rising interest rates seemed to loom large over sentiment throughout the week. Stocks started the week on a down note on news that more Wall Street analysts expected the Federal Reserve to hike rates four times in 2022—a consensus implied in futures markets. In his renomination hearing before Congress on Tuesday, Fed Chair Jerome Powell assured lawmakers that the central bank would not hesitate to contain inflation after months of saying inflation was “transitory.” Investors seemed to take the news in stride, but follow-up comments from other Fed officials over the next two days may have unsettled markets. Fed Governor Lael Brainard, President Joe Biden’s nominee for vice-chair of the central bank and noted inflation “dove,” repeated Powell’s assurances for decisive action if needed in her nomination hearing.

US – Markets & Economy

Last week’s inflation data did little to calm fears but came in broadly in line with expectations. On Wednesday, the Labor Department reported that overall consumer prices (CPI) had risen 7.0% over the past year, the most significant gain on a 12-month basis since June 1982. Core inflation excluding food and energy rose 5.5%, the most since February 1991. According to Thursday’s report, core producer prices (PPI) rose 8.3%, the most in records going back to 2011. While the consensus among analysts and policymakers is that much of 2021’s inflation spike will prove temporary, the talk seemed to increase of a possible wage-price spiral (which is permanent inflation)—in which higher prices cause workers to demand higher wages, which in turn leads companies to raise prices.

Other data offered mixed signals about the possibility of such a 1970s-style spiral. The week’s biggest surprise, arguably, was a 1.9% drop in retail sales in December—a decline that would be magnified by excluding the volatile auto market and adjusting for inflation. Many analysts pointed to caution over the omicron variant of the coronavirus in restraining shoppers, but online sales also fell sharply. Relatedly, retail inventories rose 1.3% in November, the most significant increase since February and perhaps an indication of easing supply challenges. Import and export prices also reversed course and fell during the month, while industrial production contracted slightly.

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

After climbing above 1.80% during intraday trading Monday, the yield on the benchmark 10-year U.S. Treasury note slid to 1.74% last Friday morning, as longer-term U.S. government debt rallied amid wavering risk sentiment. Meanwhile, short-term rates continued their ascent in anticipation of tighter monetary policy, leading to a flatter yield curve. Traders noted that slightly higher-than-anticipated monthly increases in the headline and core consumer price index (CPI) readings contributed to a flatter curve, based on the market’s initial reaction to the data.

Investment-grade corporate bond spreads widened alongside an active primary calendar. The issuance was met with generally tepid demand, but recent new issues in the banking sector outperformed late in the week. The macroeconomic sentiment was bolstered by Fed Chair Jerome Powell’s comments, in which he reassured investors that the Fed would control inflation as the economy rebounds.

According to traders, the high yield and broader risk markets recovered from recent weakness following Powell’s commentary on inflation and the central bank’s balance sheet reduction. Traders also noted a sense of relief among investors that the CPI numbers did not significantly surprise the upside, which led to more buying across sectors and ratings, focusing on recently underperforming names. However, the high yield market traded lower last week amid broad macro volatility as the rate hike picture weighed on equity performance.

US Treasury Markets

Interesting News Overseas

Last week shares in Europe pulled back on signals that the U.S. Federal Reserve would tighten monetary policy faster than the market had previously expected. The pan-European STOXX Europe 600 Index ended the week about 1% lower in local currency terms. France’s CAC 40 Index pulled back 1.06%, Germany’s Xetra DAX Index slipped 0.40%, and Italy’s FTSE MIB Index eased 0.27%. However, the UK’s FTSE 100 Index advanced 0.77%.

Core euro zone bond yields ended lower, mostly tracking moves in U.S. Treasury yields. Peripheral eurozone bonds and UK gilts broadly followed core markets. However, data showing stronger-than-expected UK economic growth in November appeared to moderate the decline in gilt yields.

On the other side of the world, Japan’s stock market returns were negative for the week, with the Nikkei 225 Index falling 1.24% and the broader TOPIX index down 0.90%. Concerns about more aggressive monetary policy tightening by the U.S. Federal Reserve continued to weigh on sentiment, leading to investors’ preference for value stocks over high-growth stocks and, in particular, technology names. Confidence was also dented by the government extending the ban on non-resident foreigners entering Japan until the end of February and an apparent sixth wave of the coronavirus hitting the country’s capital, Tokyo.

Against this backdrop, the yield on the 10-year Japanese government bond (JGB) rose to 0.15%, from 0.12% at the end of the previous week. JGB yields tracked U.S. Treasury yields higher amid expectations that the Fed could raise interest rates as early as March to curb inflationary pressures. This contrasts with the dovish stance of the Bank of Japan (BoJ), which continues to signal its commitment to monetary easing and is unlikely to raise short-term interest rates anytime soon. Rising JGB yields supported the yen, which strengthened to around JPY 113.8 against the U.S. dollar, from the prior week’s JPY 115.6.

Lastly, Chinese markets fell for the week. The Shanghai Composite Index shed 1.6%, and the CSI 300 Index retreated 2%, weighed by headlines about refinancing difficulties in the country’s troubled property sector.

Bloomberg reported that China’s largest banks have grown more selective about funding real estate projects by local government financing vehicles. At the same time, several developers scrambled to obtain creditors’ consent for maturity extensions and exchange offers. Other developers have intensified fundraising campaigns as traditional financing routes like presales have dried up.

China Evergrande Group, the world’s most indebted property company, secured necessary approval from onshore bondholders to delay payments on one of its bonds. Shimao Group, which missed payment on a USD 101 million trust loan earlier this month, will meet with creditors to vote on payment extension proposals after denying reports of a fire sale, Reuters reported. Credit rating agencies Moody’s and S&P downgraded their ratings on Shimao again last week, and S&P said it withdrew its rating at the company’s request. A severe and prolonged downturn in China’s real estate sector would have significant economy-wide reverberations, the World Bank warned in its Global Economic Prospects report.

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