Last Week in Review June 17, 2022

Last Week In Review

The Federal Reserve’s most aggressive rate hike since 1994 raised recession fears and sent stocks sharply lower for a consecutive week. Last week the S&P 500 Index recorded its worst weekly decline since March 2020 and entered a bear market, ending the week nearly 24% below its January peak. Meanwhile, the percentage of S&P 500 members trading above their 50-day moving average sank below 5% during the week, the lowest level since pandemic fears battered shares more than two years ago.

Last Monday, two other negative multiyear thresholds happened: every member of the S&P 500 was in negative territory at one point, something that hasn’t happened since at least 1996, while the NYSE advance/decline ratio was the most negative it has been since 2007.

Traders and portfolio managers I spoke to attributed the negative start to the week to continuing inflation fears, which had been fanned the previous Friday by an upside surprise in May consumer inflation data. Last Monday, The Wall Street Journal reported that Fed officials were considering raising rates by 75 basis points (bps, or 0.75 percentage points) at their meeting concluding Wednesday—an outcome on which the markets had priced in only a 2% likelihood the previous week. The odds seemed to increase further on Tuesday after former New York Fed President William Dudley told a conference that he expected a 75 bps hike. Investors did not appear reassured by downside surprises in core (less food and energy) producer price inflation data reported the same day.

Indeed, the Fed’s policy committee announced Wednesday afternoon that it was raising the federal funds rate by 75 bps to a target range of 1.50% to 1.75%, its highest level since early 2020, although one member dissented. Stocks rallied as investors appeared to welcome what Fed Chair Jerome Powell termed the “strong move” in his post-meeting press conference, as well as his expressed willingness to raise rates in another 75 bps increment if necessary—although he does not expect rate increases of this magnitude to be “common.” At the same time, Powell insisted that “there’s no sign of a broader slowdown that I can see in the economy.”

US – Markets & Economy

The mood on Wall Street seemed to sour last Thursday, perhaps due to worrisome signs that the economy might be more vulnerable to a slowdown than Powell envisioned. In particular, several reports indicated that the housing sector was already feeling the impact of Fed tightening and the surge in mortgage rates: Building permits fell 7% in May to their lowest level since last September, while housing starts sank 14.4%, the most significant drop since the onset of the pandemic. Weekly jobless claims also came in higher than expected (229,000 versus roughly 210,000), and a surprise contraction in Mid-Atlantic factory activity—the first since May 2020—mirrored a contraction, and weaker-than-expected reading in the New York region reported earlier in the week.

Retail sales data, reported Wednesday, further stoked recession fears. Overall sales fell 0.3% in May, dragged lower by a sharp decline in auto purchases, which partly reflected higher rates on car loans. Sales excluding autos were also surprised on the downside, however, rising only 0.5% versus consensus expectations of around 0.8%. Excluding gasoline, sales rose only 0.1%. The data confirmed that consumers were buying less in real terms, given the higher year-over-year increase in consumer inflation (8.6%) than in non-inflation-adjusted retail sales (8.1%).

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

Inflation and rate fears pushed the yield on the benchmark 10-year Treasury note briefly to 3.49% on Tuesday, its highest level in over a decade. (Bond prices and yields move in opposite directions.) Powell’s reassurances and the sluggish economic data last week sparked a relief rally, sending the 10-year note yield down to 3.23% by the close of trading on Friday, above the previous week’s level but down sharply from its intraweek high.

Tax-exempt municipals registered firmly negative returns as severe outflows from municipal bond funds industrywide exacerbated selling pressures. At the broad market level, municipals underperformed U.S. Treasuries by a wide margin. According to our traders, few new deals came to market as continued interest rate volatility and thin liquidity effectively halted issuance.

Investment-grade corporate bonds declined amid risk-off sentiment and relatively challenging liquidity early in the week, with more-volatile bonds and bank-sector debt underperforming. After rallying in the wake of the Fed meeting, corporate bonds traded lower again, in line with other risk assets. Primary issuance stalled as no new deals reached the market.

High yield bonds experienced weakness, with riskier market segments underperforming and a pickup in outflows industrywide. The asset class retracted some of its earlier losses after the Federal Reserve’s meeting, but the positive sentiment was short-lived as risk assets traded lower on Thursday. Traders noted that the new issue market remained quiet throughout the week as volatility kept issuers on the sidelines.

Bank loans were mixed as the week began. However, sentiment turned increasingly bearish after investors appeared to contemplate what a continued upward move in rates would do to economic growth.

US Treasury Markets – Current Rate and Weekly Change

Interesting News Overseas

Shares in Europe fell sharply on concerns that economic growth may stall after several central banks announced rate increases. The pan-European STOXX Europe 600 Index ended the week 4.60% lower in local currency terms. Major indexes also recorded material declines. Germany’s DAX Index dropped 4.62%, France’s CAC 40 Index declined 4.92%, and Italy’s FTSE MIB Index lost 3.36%. The UK’s FTSE 100 Index pulled back 4.12%.

The European Central Bank’s (ECB) Governing Council held an unscheduled meeting after a jump in borrowing costs for some heavily indebted member states (Italy) stoked fears of another eurozone debt crisis. In a statement released after this ad hoc meeting, the ECB indicated it would take action to stem the widening yield spreads between member states’ sovereign bonds. These measures would include targeted adjustments to how it reinvests the proceeds from maturing debt in the portfolio associated with the central bank’s pandemic emergency purchase program. The ECB will also seek to develop a new tool to help alleviate the “fragmentation” in borrowing costs.

The Swiss National Bank unexpectedly raised interest rates for the first time in 15 years by half a point to -0.25% to subdue inflation. The central bank increased its inflation forecasts substantially and said further rate hikes could not be ruled out.

The Bank of England (BoE) raised its key interest rate to 1.25%, an increase of 25 basis points. Three of the nine policymakers voted for a 50-basis-point rise. The bank said: “The committee will be particularly alert to indications of more persistent inflationary pressures and will, if necessary, act forcefully in response.” The BoE revised its inflation outlook higher, projecting that the year-over-year change in consumer prices would be slightly above 11% in October, partly reflecting expectations for higher household energy costs. The updated forecast also calls for an economic contraction of 0.3% in the second quarter instead of the 0.1% expansion projected in the BoE’s May policy report.

Japan’s stock markets registered sharp losses for the week, with the Nikkei 225 Index down 6.69% and the broader TOPIX index falling 5.52%. Recession fears were sparked by the U.S. Federal Reserve’s announcement of its steepest interest rate rise since 1994, alongside other central banks’ moves to curb surging inflation. Continuing its divergence from global peers, the Bank of Japan (BoJ) maintained its ultralow interest rates. Against this backdrop, the 10-year Japanese government bond (JGB) fell slightly to 0.24%, from 0.25% at the end of the previous week. It briefly breached the top of the BoJ’s 0.25% policy band early in the week, prompting the central bank to announce an additional, unscheduled outright purchase of JGBs. The yen continued to hover around a 24-year low but strengthened modestly over the week, to around JPY 134.3 against the U.S. dollar, from the prior week’s JPY 134.4.

Lastly, Chinese stock markets advanced in hopes that a pickup in fixed asset investments would put the country’s economy back on track. The broad, capitalization-weighted Shanghai Composite Index added 1.0%, and the blue-chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, rose 1.4% to its highest level in three months, according to Reuters.

China’s state planner approved ten fixed asset investments worth CNY 121 billion (USD 18.1 billion) in May, a more than sixfold jump from April. Sentiment also received a boost after data showed dramatic growth in industrial production in May and increased policy support following weak housing market data. News of relatively relaxed coronavirus curbs in Beijing also lifted investors’ optimism. The city is returning to regular testing and targeted lockdowns rather than mass testing and lockdowns of entire districts.

The yuan remained broadly flat against the U.S. dollar and ended at 6.70 against the greenback from 6.69 last week. The 10-year Chinese government bond yield rose to 2.83% from 2.81% a week ago after the U.S. Federal Reserve raised interest rates and signaled more policy tightening in the months ahead. These expectations were reflected in another month of large outflows from onshore bond markets in May at USD 16 billion—the fourth straight month of sales—bringing the total drawdowns since February to USD 61 billion.

China’s holdings of U.S. Treasuries tumbled in April to their lowest level since May 2010, as Treasury prices fell during the month in anticipation of the Fed tightening. China is the second-biggest non-U.S. holder of Treasuries after Japan.

The economic picture showed some improvement. May industrial production rose slightly year on year versus expectations of a contraction, and fixed asset investments increased more than expected in the year’s first five months. Retail sales contracted less than forecast as virus restrictions in Shanghai and other areas were eased during the month, allowing production to resume gradually. Property sales as measured by floor space showed a marginal improvement, declining 31.9% year on year in May compared with April’s 39.0% contraction.

However, home prices fell in May for the ninth month. China’s labor market also showed signs of weakness. The unemployment rate in 31 major cities rose to a record high of 6.9%, while the youth jobless rate rose to a record 18.4%, Bloomberg reported, citing official statistics.

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