Markets were down sharply again last week as the Fed ratcheted up its efforts to tame inflation. The FOMC started by raising overnight interest rates by 75bp, a move that had already been priced into fixed income markets following the release of higher-than-expected CPI data the week before.
But as is typically the case with Fed policy, the ensuing comments from Chairman Jerome Powell proved more consequential than the actual rate decision. In a speech that echoed ECB Chairman Mario Draghi’s famous “whatever it takes” moment from 2012 (albeit with a different policy goal in mind), Powell noted that the Fed remains “strongly committed” to bringing inflation down, and that it has “the tools we need and the resolve it will take”. Subsequently, the Fed’s annual report to Congress noted that the FOMC’s commitment to restoring price stability was “unconditional.”
Market participants interpreted these comments to mean that the Fed will continue to aggressively raise rates and will ultimately be willing to cause a recession if necessary to bring inflation under control. Stocks were sharply lower as a result, with the S&P 500 recording its second consecutive week of a greater than 5% decline.
Bond yields finished higher across the curve as investors priced in ~2 additional 25bp Fed rate hikes this year. Credit spreads widened, magnifying the price declines in municipal and corporate bonds.
Most commodity prices finished lower on the week, including oil which shed over $10 to finish under $110/barrel. Mercifully, gasoline prices finally stopped rising across most of the country, with the national average falling by 1c to $4.99/gallon.
Economy & Earnings
Annualized US GDP growth fell to -1.5% in Q1 on headwinds
from trade, private investment, and government spending. Personal consumption remains strong, however, suggesting growth should resume for the balance of the year. Consensus 2022 GDP stands at +2.6%.
The S&P 500’s fwd P/E of 16x is above the long-term historical average,
and valuation metrics like CAPE (cyclically adjusted P/E ratio) suggest that compound annual returns over the next decade are likely to be in the single digits. That said, many growth stock valuations are at multi-year lows after the recent selloff, suggesting future returns in some sectors could be above-average.
Rates have risen across the curve in early 2022 as the market prices
in a number of Fed Funds rate hikes. Fed Fund Futures markets are currently pricing in a total of fourteen 25bp rate hikes in 2022, with an implied Fed Funds target rate floor of 3.50% by year end.
Inflation is currently high as supply chain disruptions, labor shortages, and
rising energy prices have impacted input costs for many businesses. The Fed has begun raising overnight interest rates in order to tame inflationary pressures.