Last Week in Review, May 13, 2022

Last Week In Review

Last week stocks recorded more losses as investors appeared to grow increasingly skeptical that the Federal Reserve will be able to achieve a “soft landing” for the economy by raising rates enough to tame inflation without causing a recession. The Cboe Volatility Index (VIX) remained elevated but slightly below its recent intraday high on May 2. High trading volumes in exchange-traded volatility funds indicate high levels of hedging activity. Many cryptocurrencies plunged in value, further suggesting a solid risk-off environment.

It marked the sixth consecutive weekly decline for both the S&P 500 Index and the Nasdaq Composite and the seventh for the Dow Jones Industrial Average—the longest stretch for the latter since 2001, according to The Wall Street Journal. At its low point on Thursday, the S&P 500 was down nearly 18% from its peak, well into correction territory but just above the -20% performance threshold that typically defines a bear market. The benchmarks pared some of their losses on Friday, helped by a rally in Tesla shares after CEO Elon Musk tweeted that his deal to buy Twitter—partly funded by sales of a portion of his considerable stake in the electric car maker—was “on hold.” Later in the afternoon, he corrected the tweet by saying he was still committed to the deal.

Traders I spoke to noted the five themes behind the market’s continued declines: the Fed’s accelerated pace of monetary tightening, persistently high inflation data, worries about slowing growth, disruptions caused by China’s strict COVID-19 lockdowns, and Russia’s invasion of Ukraine.

US – Markets & Economy

Negative signals on each theme arguably emerged during last week, but it may have been Wednesday’s inflation data that weighed the most on sentiment. Headline consumer inflation fell back a bit from March’s pace but not as much as expected, rising 8.3% year over year versus consensus estimates of around 8.1%; likewise, core consumer inflation (excluding food and energy) pulled back less than expected to 6.2% versus 6.0%. Core producer prices rose slightly less than expected in April, but March’s monthly gain was revised to a record 1.2%.

Particularly worrying to investors may have been the 0.7% monthly surge in consumer prices for services (less energy services), indicating that inflationary pressures were moving beyond manufacturing and energy supply chains and becoming more broadly embedded in the economy. Airline fares jumped 18.6% over the month, the largest increase on record (ever).

The University of Michigan’s preliminary survey of consumer sentiment in May, released last Friday, indicated the steep toll inflation took on Americans’ confidence in their finances. The survey’s sentiment gauge fell much more than expected (to 59.1 versus consensus estimates of roughly 64) and hit its lowest level in 13 years. Survey respondents reported the worst conditions for buying appliances and other durable goods since researchers began asking the question in 1978.

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 smaller-than-expected decline in consumer inflation caused a brief jump in the yield of the benchmark 10-year U.S. Treasury note on Wednesday, but it ended sharply lower for the week and fell back below 3.0%. (Bond prices and yields move in opposite directions.) Portfolio managers observed signs that the typical inverse correlation between equities and Treasuries returned last week as stock prices fell meaningfully.

The broad tax-exempt debt market traded lower over most of the week despite the rally in U.S. Treasuries. Along with an uptick in new issuance, continued outflows from municipal bond mutual funds posed a strong headwind to market performance. However, traders reported that cash flows into exchange-traded funds provided some support to the front end of the yield curve. According to traders, new offerings were forced to re-price to higher yields, reflecting investor demands for higher-coupon structures.

An uptick in overnight demand from Asia for investment-grade corporate bonds, with the demand focused on higher-quality, longer-maturity credits. However, corporate credit spreads widened over the week alongside moves lower in the equity market and broader risk-off sentiment. Against the weaker macro backdrop, primary issuance was relatively subdued, with the weekly total falling short of expectations. Weakness in the high yield market reflected the pullback in equities, and credits from companies that missed earnings and revised guidance lower were notable underperformers. The primary market was quiet as most issuers remained on the sidelines amid the heightened volatility.

Bank loans followed broader risk markets lower. Overall, lower-quality credits and out-of-favor sectors continued to underperform. Still, traders noted that some investors continued to rotate out of loans while looking for attractive values in high-yield bonds. Earnings season was another driver of trading activity, as companies that beat expectations generally performed in line with the broader market, whereas companies that fell short of expectations were punished.

US Treasury Markets – Current Rate and Weekly Change

Interesting News Overseas

Shares in Europe rebounded from earlier weakness to finish higher, despite ongoing concerns about inflation, tightening monetary policy, and the economic outlook. The pan-European STOXX Europe 600 Index ended 0.83% higher in local currency terms. The main market indexes advanced. Germany’s Xetra DAX Index climbed 2.59%, Italy’s FTSE MIB Index tacked 2.44%, and France’s CAC 40 Index added 1.67%. The UK’s FTSE 100 Index ticked up 0.41%.

Core eurozone government bond yields, fell amid a broad developed market bond rally led by U.S. Treasuries. Peripheral eurozone and UK government bond yields largely tracked yields in core markets.

European Central Bank (ECB) President Christine Lagarde said in Slovenia that the ECB’s bond-buying program could end “early in the third quarter” and be followed by a rate increase “only a few weeks” later. The comments are the clearest sign yet from Lagarde that the ECB could move on rates sooner rather than later. Since the April policy meeting, a growing number of policymakers have appeared to lend their backing to increasing interest rates in July. Joining their ranks during the week were German central bank President Joachim Nagel, who said he “will advocate a first step normalizing ECB interest rates in July,” and Frank Elderson, the newest member of the executive board, who said that the ECB could consider raising rates in July “dependent, as always, on the incoming data.”

Russia imposed sanctions on European Union (EU) energy companies, including Gazprom Germania, which was taken over by Germany last month. Russia’s state-owned gas company Gazprom said it would cut shipments to Europe via the Yamal pipeline, which runs from Poland to Germany. Earlier, Ukraine’s pipeline operator stopped flowing through one of the two pipelines transporting Russian gas through the country to Europe, blaming interference by Russian armed forces.

Meanwhile, EU diplomats could drop proposals to ban Russian oil temporarily while moving ahead with other measures that would be part of the sixth package of sanctions, according to the POLITICO website, citing diplomats. The ban is opposed by countries that rely on Russian oil supplies, including Hungary. Separately, the EU dropped a plan to stop its shipping industry from carrying Russian crude oil after objections from Malta and Greece, the Financial Times newspaper reported.

Japan’s stock markets fell over the week as expectations that the U.S. Federal Reserve would aggressively tighten monetary policy, concerns about slowing global growth, and the economic implications of the war between Russia and Ukraine continued to weigh on risk appetite. However, broadly positive earnings developments and renewed expansion in service sector business activity lent some support. The Nikkei 225 Index lost 2.13%, and the broader TOPIX index was down 2.70%. The 10-year Japanese government bond yield finished the week broadly unchanged at 0.24%, while the yen strengthened to around JPY 128.12 against the U.S. dollar, from about JPY 130.41, although it remained at very depressed levels.

Against the backdrop of monetary accommodation being reduced in the U.S. and Europe, and amid some speculation that the Bank of Japan (BoJ) should also scale back its aggressive monetary easing, BoJ Governor Haruhiko Kuroda reiterated the central bank’s commitment to its current monetary policy stance. Japan’s economic growth has not recovered to pre-pandemic levels. According to Kuroda, the expected rise in prices in the short run—driven by energy costs—will lack sustainability, with no sharp rise in medium- to long-term inflation expectations. Given current developments in economic activity and prices in Japan, the BoJ considers it necessary to continue with aggressive monetary easing to support the economy’s post-pandemic recovery and achieve the central bank’s price stability target of 2% annual inflation.
Lastly, Chinese stocks rallied as a fall in coronavirus cases, and encouraging comments from the securities regulator lifted investor sentiment. The broad, capitalization-weighted Shanghai Composite Index added 2.7%, and the blue-chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, rose 2.1%.

The China Securities Regulatory Commission aims to increase the participation of institutional investors in the country’s stock markets and expand the investible universe of the exchange link with Hong Kong, according to an interview carried on state media with Vice Chairman Wang Jianjun.

The 10-year Chinese government bond yield declined to 2.834% from 2.848% after the People’s Bank of China (PBOC) reiterated pledges to maintain sufficient liquidity and stable credit growth in its first-quarter monetary policy report.

A week ago, the yuan weakened to CNY 6.80 per U.S. dollar from CNY 6.67. The currency has fallen more than 5% against the greenback in the last three weeks amid rising U.S. interest rates, the Russia-Ukraine war, slowing domestic growth, and speculation that the central bank will act to slow its depreciation.

The yuan’s slump is an unwelcome development for issuers of dollar bonds, many of which are in the debt-laden property sector and struggling with slowing sales, weak prices, and refinancing pressures. The property sector’s liquidity crisis continued as Sunac China Holdings and Zhongliang Holdings became the latest developers to discuss debt solutions for their repayment obligations.

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