Last Week in Review – March 18, 2022

Last Week In Review

Last week moved higher, ending a two-week losing streak and reclaiming much of the ground lost over the past month. Traders I spoke with said that markets were supported by multiple factors, including falling oil prices, news that Russia had avoided defaulting on its sovereign debt, oversold conditions, and the outcome of the Federal Reserve’s monetary policy meeting. While fighting continued in Ukraine, investor sentiment was also buoyed during the week by continued negotiations to end the conflict. Gains were widespread across the major indexes, with the tech-heavy Nasdaq Composite staging the biggest rally.

As expected, the Fed raised its short-term lending rate by 25 basis points (a quarter percentage point) at its March meeting, moving the fed funds target rate from near zero to 0.25% to 0.50%. It was the first rate hike by the Fed since 2018. It marked a critical step away from the ultra-accommodative monetary policy the central bank instituted in the early days of the pandemic. According to the median projection, policymakers also released an updated economic forecast, which showed they expected to raise rates seven times in 2022. In addition, they downgraded their forecast for economic growth while upwardly revising inflation projections.

I believe the inflation forecast shows that policymakers see a broadening in price pressures beyond the pandemic-related disruptions that caused the initial price spike. I would also note that the Fed intends to shift the stance of monetary policy from accommodative to neutral and then to slightly restrictive before the end of next year, another sign that it wants to move at a fast pace to address inflation. Equity markets seemed satisfied with the Fed’s approach and rallied following the meeting.

US – Markets & Economy

Besides the Fed’s announcement last week, economic data seemed to have a limited impact on markets. February retail sales were disappointing, although the January numbers were revised upward. Continuing claims for unemployment insurance fell to a 52-year low, showing continued strength in the labor market. In a possible sign of peaking inflation, the headline producer price index decelerated during February, and the gain in core prices held steady with January’s pace. Meanwhile, mortgage rates in the U.S. soared, surpassing 4% for the first time in almost three years.

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

Last week, U.S. Treasury yields shifted higher in response to hawkish signals from the Federal Reserve. (Bond prices and yields move in opposite directions.) Yield increases were most notable in shorter-maturity Treasuries, which are generally more sensitive to changes in monetary policy. Amid a further flattening of the Treasury curve, the five-year yield briefly eclipsed the yield of the 10-year Treasury note during intraday trade Wednesday and did so again early Friday morning.

According to traders, outflows from municipal bond funds continued to drag on technical conditions in the municipal bond market. However, modest levels of new issuance and more attractive valuations relative to Treasuries helped stabilize the market later in the week. Both investment-grade and high-yield securities performed well following the Fed rate hike in the corporate bond market.

US Treasury Markets – Current Rate and Weekly Change

Interesting News Overseas

In Europe, shares gained ground for a second consecutive week amid cautious optimism that negotiations between Russia and Ukraine could yield a peace plan. China’s announcement that it would take measures to support the economy and financial markets also appeared to boost sentiment. In local-currency terms, the pan-European STOXX Europe 600 Index advanced 5.43%. Germany’s Xetra DAX Index added 5.76%, France’s CAC 40 Index tacked on 5.75%, and Italy’s FTSE MIB Index climbed 5.13%. The UK’s FTSE 100 Index gained 5.13%.

Core eurozone bond yields climbed modestly. At first, the benchmark German 10-year bund yield rose on progress in Ukraine-Russia peace talks and growing expectations that central banks would pursue more-hawkish policies to quell surging inflation. Yields moderated after ceasefire negotiations appeared to stall. Peripheral eurozone bond prices found support during the week. Reports that the European Union (EU) was mulling fresh joint debt issuances to fund energy and defense spending buoyed the price of Italian government debt and other sovereign issues. UK gilt yields fell. Although the Bank of England (BoE) raised interest rates, markets discerned a more dovish tone in policymakers’ comments and scaled back expectations for more hikes.

The BoE raised interest rates to 0.75% from 0.50%, aiming to curb inflation that it now expects to reach 8% by the end of June, partly due to Russia’s invasion of Ukraine. “Some further modest tightening in monetary policy” might be needed over the coming months, the BoE asserted, acknowledging “there were risks on both sides of that judgment depending on how medium-term prospects evolved.” Markets interpreted the language to be more dovish in tone, a view reinforced by Deputy Governor for Financial Stability Sir Jon Cunliffe’s vote against a third back-to-back hike. Cunliffe argued that the hit to business confidence and household incomes from the Ukraine-Russia conflict would slow the economy and bring down inflation.

The BoE’s message appears to have become more dovish because of the potential real economic effects of the Ukraine conflict. However, I still see the potential for three more rate increases this year because of evidence of decoupling inflation expectations, the emergence of a price-wage spiral, a tight labor market, and a resilient services sector.

However, in Japan, the BoJ’s March monetary policy meeting reaffirmed the central bank’s stance as among the most dovish globally. The BoJ maintained its short-term policy interest rate at -0.1% and its target for the 10-year JGB yield at around 0%. It will continue with quantitative and qualitative monetary easing with yield curve control as long as it is necessary to achieve and maintain its price stability target of 2%. In February, Japan’s core consumer prices rose 0.6% as energy costs soared due to higher oil prices.

The BoJ said that Japan’s economy has picked up as a trend, although some weakness—notably a pause in the pickup in private consumption—has stemmed from the impact of the coronavirus pandemic. It pointed to market volatility due to Russia’s invasion of Ukraine and significant commodity price rises and cautioned that future developments warrant attention. Inflation expectations have risen moderately. However, BoJ Governor Haruhiko Kuroda stated that there is no need to tighten monetary policy in response to a transitory trend instead of a sustained one. He also asserted that a gradually depreciating yen has a more beneficial impact on the economy than a negative one.

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