Last Week in Review – July 1, 2022

Last Week In Review

Last week the major indexes surrendered a portion of the previous week’s substantial gains as worries grew that the Federal Reserve’s fight against inflation would push the economy into recession. The S&P 500 Index closed out its worst first half of the year since 1970, as was widely reported, although the decline was amplified by the index reaching its all-time high on January 3. Typically defensive segments within the index, such as utilities and consumer staples, held up best, while consumer discretionary and information technology shares were fragile.

Much of last week’s economic data missed consensus expectations, and some signals suggested that economic activity might be slowing. Traders I spoke with noted that the selling started on Tuesday morning when the Conference Board’s consumer confidence index came in much lower than anticipated. A measure of manufacturing activity in the Mid-Atlantic region fell to levels not seen since the height of the pandemic.

US – Markets & Economy

The middle of the week brought closely watched data on May personal consumption expenditures (PCE), which indicated that consumers were also pulling back. Adjusted for inflation, purchases fell 0.4% in May, the first decline in 2022, driven by a 1.6% drop in goods purchases; purchases of services rose 0.3%, but much of the increase was driven by spending on housing and health care. Inflation-adjusted disposable income, reported Thursday, fell 0.1% over the month.

The PCE data were enough to push the Atlanta Fed’s GDPNow model estimate of annualized growth in the second quarter down to -1.0%. If confirmed, this would meet one commonly accepted definition of a recession—two consecutive quarters of negative growth—given the 1.6% contraction in the first quarter. However, many economists note that a record trade deficit early in the year skewed the data.

Nevertheless, much of the week’s data suggested continued, if slowing, expansion. May durable goods orders surprised to the upside, especially when controlling for defense (0.6% versus roughly -0.5%). Gauges of current factory activity indicated continued expansion but at the slowest pace since the summer of 2020. While anecdotal reports of scattered hiring freezes and layoffs continued to intensify, weekly jobless claims came in roughly in line with expectations at 231,000—within a narrow band of 231,000 to 232,000, where they have remained for four consecutive weeks. Claims bottomed at 181,000 for the week ended April 24.

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 sluggish economic data appeared to help push the 10-year U.S. Treasury Note yield as low as 2.79% in Friday trading, its lowest monthly level. (Bond prices and yields move in opposite directions.)

Traders and portfolio managers cited recession fears as an underlying driver of the week’s rally in municipal bonds. However, the tax-advantaged market lagged U.S. Treasuries as continued fund outflows and weak demand for new issuance held back its performance.

A constructive start to the week in the investment-grade corporate bond market spurred primary issuance, and this uptick in supply pushed the market lower. This trend was exacerbated by mixed macroeconomic sentiment as market participants weighed Fed Chair Jerome Powell’s mid-week remarks, in which he reinforced the Fed’s commitment to lower inflation against the lower-than-expected core PCE inflation reading. Ultimately, primary issuance fell short of weekly expectations, and the new deals that reached the market were met with adequate demand.

High yield bonds traded lower along with equities. Traders reported that buyers adjusting positions ahead of quarter-end and sellers raising cash drove most of the market’s activity. One anticipated new deal was announced before the primary market shut down ahead of the holiday weekend. At the same time, the retail segment experienced weakness after a disappointing earnings report from Bed Bath & Beyond increased negative sentiment across the sector.

Broad risk-off sentiment weighed on the performance of bank loans. Investors expect a 75-basis-point (0.75 percentage point) rate hike at the late-July Federal Reserve meeting and another 50-basis-point increase at the September meeting. Our traders noted that higher-rated loans were better amid limited support for the lower-quality paper. Negative flows from the asset class drove most of the loan market’s selling activity.

US Treasury Markets – Current Rate and Weekly Change

Interesting News Overseas

Shares in Europe fell on fears that soaring inflation and rising interest rates could hit earnings and tip economies into a recession. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.40% lower, while Germany’s DAX Index pulled back 2.33%, France’s CAC 40 lost 2.34%, and Italy’s FTSE MIB dropped 3.46%. The UK’s FTSE 100 Index declined 0.56%, supported by a weaker British pound against the U.S. dollar. UK stocks tend to perform relatively well when the pound falls because many companies that are part of the index are multinationals with overseas revenues.

Core euro zone bond yields decreased. Yields increased initially amid inflation concerns and ahead of speeches by central bank officials at the European Central Bank (ECB) annual meeting. Still, lower-than-expected German inflation calmed fears, leading yields lower overall. Peripheral eurozone and UK government bond yields broadly tracked core markets.

While hawkish ECB policymakers continued to bring up the possibility of a 50-basis-point interest rate hike as early as July, ECB President Christine Lagarde reiterated guidance for an increase of 25 basis points followed by another hike in September, the size of which depending on incoming data. At the central bank’s annual conference in Portugal, she stated that the ECB needed to act “in a determined and sustained manner, incorporating our principles of gradualism and optionality” to tackle elevated inflation. She also said that a larger increase in the policy rate would be more appropriate “if the medium-term inflation outlook persists or deteriorates.”

On the other side of the globe, Japan’s stock markets generated a negative return for the week, with the Nikkei 225 Index falling 2.10% and the broader TOPIX index down 1.16%. The escalating risk of a global recession prompted by major central banks aggressively raising interest rates to combat inflation continued to pose a headwind.

Worsening sentiment among Japan’s large manufacturers and a bigger-than-expected drop in industrial production also weighed on risk appetite. Meanwhile, record temperatures and concerns about power shortages prompted the government to signal a renewed reliance on nuclear reactors. Against this backdrop, the yield on the 10-year Japanese government bond finished the week broadly unchanged at 0.23%. The yen remained near a 24-year low against the U.S. dollar—with weakness mainly attributable to the divergent monetary policies of the Bank of Japan (BoJ) and the U.S. Federal Reserve—finishing the week at the low end of the JPY 135 range.

The Bank of Japan’s quarterly Tankan corporate survey showed that sentiment among large manufacturers deteriorated in the three months to the end of June. The worsening reflected concerns about China’s coronavirus lockdowns and prolonged supply chain constraints. On the other hand, confidence among services sector firms, which benefited from the lifting of domestic coronavirus restrictions, improved. Separate data showed factory output fell sharply in May, with vehicle production particularly weak.

Core consumer prices in Tokyo rose 2.1% in June, heightening the chances that nationwide inflation will continue to rise in the coming months. While the BoJ’s inflation expectations have increased—particularly in the short term and at a more moderate pace over the medium to long term—inflation, excluding such factors as energy, remains low compared with other G-7 nations.

Lastly, Chinese stocks advanced on the back of solid factory data, easing coronavirus restrictions for travelers. Reuters reported that the broad, capitalization-weighted Shanghai Composite Index rose 1.3%, and the blue-chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, gained 1.6%.

On Tuesday, China halved the quarantine times for inbound travelers. Under the new policy, travelers must spend seven days in a quarantine facility and then monitor their health at home for three days, down from 14 days under hotel quarantine in many parts of the country and as many as 21 days of isolation in the past. China’s President Xi Jinping said the current pandemic strategy was “correct and effective and must be upheld unwaveringly.”

Reuters data showed that the yuan weakened to CNY 6.70 per U.S. dollar late Friday from CNY 6.69 last week. The 10-year Chinese government bond yield rose slightly to 2.847% from 2.816% a week ago, according to Dow Jones, as issuance increased. The state-backed China Securities Journal reported that the sale of Chinese local government bonds for June is estimated to reach a single-month record high of CNY 1.93 trillion.

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