Last Week in Review – January 28 2022

Last Week In Review

Late gains last week helped the large-cap benchmarks move higher, but not before most major indexes moved temporarily into correction territory or down more than 10% from recent highs. The small-cap Russell 2000 Index lagged and ended the week down nearly 20% from its November peak, leaving it just outside of a bear market. Volatility, as measured by the CBOE Volatility Index (VIX), reached its highest level since the early months of the pandemic. Energy stocks rallied as international oil prices pushed above USD 90 per barrel, driven in part by the continued massing of Russian troops along the border with Ukraine.

Fears that the Federal Reserve might be “behind the curve” and forced to raise short-term interest rates quickly to tame inflation weighed heavily on sentiment. As expected, the Fed’s monetary policy committee met last week and kept interest rates steady. In his post-meeting press conference last Wednesday, however, Fed Chair Jerome Powell left open the possibility that policymakers would raise rates in 2022 more than the three quarter-point hikes they had signaled after their December meeting, with the first increase coming in March. According to CME Group data, futures markets at the end of the week were pricing in a significant potential for at least 125 basis points (1.25%) of rate increases in 2022.

Traders I spoke with seemed primarily focused on the Fed’s plans to reduce its balance sheet by selling its holdings of Treasuries and agency mortgage-backed securities. Powell said that policymakers were only now discussing how a balance sheet reduction would work but expected to announce more details following the March meeting of the Federal Open Market Committee. The chair also acknowledged that the Fed’s roughly USD 8.9 trillion balance sheet is substantially larger than it needs to be, making substantial shrinkage necessary.

US – Markets & Economy

Powell also stressed that economic conditions now are much stronger than in prior cycles, particularly given the record number of open jobs. Indeed, the Commerce Department’s first estimate of economic growth in the fourth quarter showed gross domestic product rising at an annualized rate of 6.9%, well above consensus estimates of roughly 5.5%; for 2021, the economy grew by 5.7%, its fastest pace since 1984.

Higher-frequency economic indicators indicated some slowing in January, however. IHS Markit’s composite gauge of service and manufacturing activity fell to 50.8—barely in expansion territory and its lowest level in 18 months—indicating that the economy had stalled mainly as the rapidly spreading omicron variant of the coronavirus restrained consumers and exacerbated supply challenges. (Readings of 50 mark the dividing line between expansion and contraction.) The University of Michigan’s gauge of consumer sentiment was revised lower to 67.2, its lowest level since November 2011, as Americans worried about inflation and falling real wages.

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 increased in response to the hawkish Fed signals, but traders noted that the IHS Markit data may have helped temper the rise, along with the tensions between the U.S. and Russia. (Bond prices and yields move in opposite directions.) The broad tax-exempt bond market registered negative returns and underperformed Treasuries, which were hampered in part by notable outflows from municipal bond funds industrywide. However, following a sell-off across the municipal yield curve, traders observed improved demand late in the week—particularly among long maturities—from bond buyers who typically invest in taxable fixed income sectors.

The Fed’s policy meeting also seemed to weigh on investment-grade corporate bonds, although higher-volatility energy-sector bonds outperformed the broader market in the wake of the meeting. Primary issuance was subdued and fell short of weekly expectations. According to traders, the high yield bond market traded lower as the prospect of tighter Fed policy and decelerating economic growth weighed on risk assets. Investors also closely monitored the Ukraine situation, partly due to concerns about the potential impact on the energy sector, which carries a heavyweight in high yield bond indexes.

US Treasury Markets – Current Rate and Weekly Change

Interesting News Overseas

Shares in Europe fell for a fourth consecutive week, extending declines on rising concerns about interest rate increases and escalating tensions between Russia and the West. The pan-European STOXX Europe 600 Index ended the week 1.87% lower in local currency terms. The major indexes in Germany and Italy suffered similar pullbacks, while France’s CAC 40 Index slid 1.45%. The UK’s FTSE 100 Index slipped 0.37%.
Yields on the core eurozone, peripheral eurozone, and UK bonds increased inflation concerns and tightened monetary policy.

Japan’s stock markets generated a negative return for the week, with the Nikkei 225 Index down 2.92% and the broader TOPIX index falling 2.61%. The markets slumped after the U.S. Federal Reserve signaled that it plans to steadily tighten monetary policy, with high-growth technology companies leading the declines. The sentiment was also dampened by Japanese authorities’ decision to extend quasi-states of emergency to more prefectures as the country’s daily COVID-19 cases reached a record high and the omicron variant continued to spread rapidly in Tokyo and elsewhere. Against this backdrop, the 10-year Japanese government bond yield rose to 0.17%, from 0.13% at the end of the previous week, tracking U.S. Treasury yields higher on the Fed’s hawkish outlook for interest rates. The yen weakened to around JPY 115.55 against the U.S. dollar from the prior week’s JPY 113.68.

Speaking before parliament, Bank of Japan (BoJ) Governor Haruhiko Kuroda reiterated the central bank’s commitment to ultra-loose monetary policy, which he expects to improve corporate profits and economic growth, in turn propping up wages and gradually accelerating consumer inflation. Kuroda said that prices might shoot up before wages pick up, making it difficult for households to meet rising living costs. Wage growth remains sluggish in Japan—Prime Minister Fumio Kishida has called for pay hikes by companies whose earnings have recovered to pre-pandemic levels.

Lastly, Chinese stocks slumped ahead of a weeklong Lunar New Year holiday as Jerome Powell’s hawkish tone following the U.S. Fed’s policy meeting raised expectations for faster monetary tightening. For the week, the Shanghai Composite Index lost 4.6%, and the CSI 300 Index slid 4.5% as traders factored in as many as five rate hikes in the U.S. this year, a development that would impact the offshore borrowing plans for many Chinese companies. The CSI 300, which struck a 16-month low during the week, is now in a bear market, falling more than 20% from its February 2021 peak.

Selling intensified as investors pared positions ahead of the holiday. Many profit warnings, mainly in the beleaguered property sector, further dampened sentiment as most China-listed companies report annual results next month. In economic readings, profits at China’s industrial firms grew at their slowest pace in more than a year and a half as demand cooled.

This message is provided for informational purposes and should not be construed as a solicitation or offer to buy or sell securities or other financial instruments. Past performance is not a guarantee of future results. Perigon Wealth Management is a registered investment adviser. More information about the firm can be found in its Form ADV Part 2, which is available upon request by calling 415-430-4140 or sending an email request to Compliance@PerigonWealth.com