Week ended May 6th, 2022
Fed, BoE hike rates; equities and bonds fizzle Summary
Although there were a slew of earnings announcements last week (160 S&P 500 companies reported), investors were mainly focused on the policy decisions and commentary/outlook from the Federal Reserve and Bank of England. Both central banks did exactly what was expected, with the Fed increasing the Federal Funds rate by 50bps on Wednesday (to 0.75%) and the BoE increasing the Bank Borrowing Rate by 25bps on Thursday (to 1.00%). Both rate rises were as expected, with equity markets Stateside rallying into this news late on Wednesday, although the rally was to be short-lived. US payroll data for the month of April, released on Friday, was strong as anticipated, indicating that for now the US economy remains in good shape. The strong economic data gives the Federal Reserve license to carry on with monetary tightening, good news in that the Fed has more manoeuvrability but bad news in that the rate rises will likely continue and eventually bite. After strong late-day rally in stocks following the Fed’s rate decision on Wednesday, both bonds and equities tanked on Thursday and continued lower on Friday. European equities got hammered even worse this week, with the FTSE 100 down 2.1% and the Euro STOXX 600 down 4.5%. Government bond yields increased in the US, UK and Eurozone. The price of gold fell and the price of WTI crude broke out of its recent range, rising to nearly $110/bbl at the end of the week (+4.9% WoW). The US Dollar strengthened further whilst Sterling and the Euro weakened.
The Fed and BoE
The Federal Reserve increased the Federal Funds rate by 50bps on Wednesday, to a range of 0.75% - 1.00%. This follows a 25bps increase in March, as the Fed tries to address ever-higher inflation that rose to 8.5% (YoY) in April. The increase in the Federal Funds rate was bang-on as expected. Mr Powell’s comments following the FOMC meeting managed to strike the perfect balance between dovish and hawkish, even as he clearly articulated the likely tightening trajectory that lies ahead. Expectations had been met perfectly, and equity investors responded to the rate rise and forward guidance in a jovial mood, pushing equities sharply higher in the last hour of Wednesday’s session. However, the feel-good faded quickly on Thursday as yields on US Treasuries headed higher, delivering a reminder of what is ahead. The Fed is in fact forecasting six additional rate rises before the end of the year and is expecting the Federal Funds rate to reach 3.00% - 3.25% by then. The FOMC minutes are here.
The Bank of England increased the Bank Rate by 25bps on Thursday, its fourth increase in as many meetings since December (2021). Similar to the Federal Reserve, the BoE also needs to address stubbornly high inflation in the UK (7%/annum in March). However, the UK economy is in a more precarious position than the US economy, so the BoE has less room to manoeuvre to simultaneously address inflation and avoid curtailing growth too severely. In the Monetary Policy Statement released on Thursday (here), the BoE said that it expects inflation to peak at 10%/annum in the last quarter of the year. It is also expected that the UK economy will contract in both 4Q2022 and 1Q2023, all of which sounds like a classic case of stagflation.
The US jobs report
The US jobs report for April was released on Friday (BLS release here). The US added 428,000 jobs in April, and unemployment fell to 3.6%. The number of unemployed fell to 5.9 million, compared to 5.7 million unemployed in February 2020 prior to the pandemic. There was some discussion about the participation rate (sideways) and wage growth (varies across sectors), but generally, the report was viewed as strong. The bond market responded by selling off at the intermediate and longer end, whilst the positive economic news did little to stabilise an already-shaky US equity market.
160 S&P 500 companies reported earnings this past week. Following the mixed results of the FAMAG stocks the week before (and throw in poor earnings from NFLX in early April), the stage was set for further disappointment as far as technology stocks, which so far have been the principal culprit leading the market lower. E-commerce and related names like SHOP (-11.6% WoW), ETSY (-7.3% WoW) and EBAY (-6.0% WoW) all disappointed in terms of earnings and their outlook / forward guidance, and shareholders certainly paid the price. In general, this earnings season has been decent although not as spectacular as that of the prior few quarters. Both top line and bottom line growth have beat more often than the long-term averages. YoY earnings (1Q22 vs 1Q21) are up 10.4%, with energy being the leading sector by a long ways (earnings +267.9%), and consumer discretionary (-29.1%) and financials (-17.1%) being the poorest. There is all kinds of excellent information in the weekly earnings report prepared by @refinitiv (#refinitivlipper), which you can find here.
What matters this coming week?
As earnings season winds down, 20 of S&P 500 companies report earnings this coming week. The Refinitiv report sited earlier has a list of companies reporting, the day/time, and analysts’ consensus EPS expectations.
As far as economic data, the focus will be on US CPI for April (to be released Weds, consensus 8.1%), UK GDP for 1Q22 (to be released Thurs, consensus 1.0% YoY), and US sentiment (to be released Friday).
ECB President Christine Lagarde speaks at conference on Wednesday, as investors seek more information on how the ECB intends to address increasing inflation in the Eurozone. The Bank of Japan releases its monetary statement on Sunday, but nothing revolutionary is expected – the BoJ will continue to be dovish and remain accommodative as it tries to stimulate the sluggish Japanese economy.
THE TABLES AND MARKET COMMENTARY
Global equity indices
As horrible as the week felt Stateside, it was significantly worse in the UK (FTSE 100 down 2.1%) and the Eurozone (STOXX 600 down 4.5%). Both the Chinese and Japanese markets were closed three days last week, perhaps a saving grace. The UK market was closed on Monday.
US equity indices
The US equity markets tried to rally as the new month began and did a good job through Wednesday. All four US indices I track were better each day to start the week. As mentioned already, the Fed’s rate decision and Mr Powell’s comments following the FOMC meeting led to a massive rally on Wednesday towards the close, only for equities to give the gains back and more in a disastrous session Thursday. Try as it may, Friday could find no support – even with a strong US jobs report – as government bond yields soared and equities continued their end-of-week capitulation. The culprit continues to be higher yields, which are having a harsh effect on the so-called high flyers in the technology sector as valuations plummet.
US Treasuries (and other government bonds)
The pain was most severe in the intermediate and long end of the curve this past week, with the yield on the 10-year UST increasing 23bps WoW. US Treasuries continue to be one of the poorest performing asset classes this year, rather remarkable when put alongside the equally poor return of US equities. Also, remember at the beginning of April when the 2-10 year curve inverted? That “recession indicator” lasted a grand total of one day. Since then, the yield curve has been back in a steepening mode, which reflects the fact that the more immediate concern for investors is inflation rather than a recession. I don’t think this takes a US recession off the table by any means, but perhaps it pushes the likelihood out further into the future.
I thought the tables below were interesting too, which show the yield migration in the 2-year and 10-year government bonds in the Eurozone, the UK and Japan, alongside the US.
The change in the 10-year in 2021 and 2022YtD is in the middle of the table (centre), and the change in the 2-year is shown in the bottom rows of that table. Although not as severe, you can see the substantial yield increases along the curve in the UK and Eurozone government bond markets, too. You can also see the case for a weaker and weaker Japanese Yen, as the BoJ maintains its 0% interest rate policy for overnight bank deposits whilst engaging in overt yield curve control along the rest of the curve, ensuring that the yield on the 10-year JGB remains at or below 0.25%.
Safe haven and other assets
Gold continues to trade in a narrow range and was down WoW, whilst the price of oil broke out on the upside with the price of WTI crude closing the week at $109.77/bbl. The Japanese Yen managed to stabilise, although how long this lasts will remain to be seen. The US Dollar continued to strengthen, with the UK Pound and Euro weakening further to levels not seen in several years. Bitcoin also sold off this week, with the benchmark crypto starting to see its resiliency break down for the first time. BTC closed the week below $36,000 for the first time since July 2021.
Corporate bonds (credit)
Yields on corporate bonds increased this week, largely reflecting the sell-off in US Treasuries. Credit spreads in high yield also widened 10bps-12bps or so, with the weaker end of the credit spectrum in high yield (CCC) widening substantially more (around 51bps through Thursday). The high yield market seems to be suggesting a flight-to-quality within the asset class, with BB bonds being the best performer.