Weekly Market Update 4/18/2022
There is little relief in sight on the inflation front. The Consumer and Producer Price Indexes for March jumped 8.5% and 11.2% year over year, respectively. Rising prices for food and energy commodities were primarily behind the surge in costs.
The stubbornly high inflation is bringing more-hawkish monetary policy comments from Federal Reserve leaders. The current consensus is that the central bank will hike the benchmark short-term interest rate by 50 basis points at next month’s Federal Open Market Committee (FOMC) meeting, and that may be the first of a few half-percentage-point increases this year.
Recent commentary also has raised the odds that the Federal Reserve Bank, perhaps as early as the May FOMC meeting, will begin to aggressively reduce its balance sheet. Its asset holdings swelled to nearly $9 trillion following the massive stimulus programs implemented to support the U.S. economy during the height of the COVID-19 pandemic. Such a reduction–via selling holdings of bonds or allowing them to mature–would remove excess liquidity from the financial system, which is contributing to the inflation problem.
Meantime, rising Treasury market yields have caught the attention of Wall Street. The yield on 10-year Treasury notes, which is used as a proxy for mortgage rates, recently topped the 2.80% mark. That is more than 100 basis points (a full percentage point) higher than where it sat on March 1st. The resultant higher borrowing costs may ultimately slow the pace of economic expansion.
The early April inversion of the Treasury market yield curve–in which the yield on the two-year note exceeded that of the longer duration 10-year bond–has raised some red flags about the U.S. economy. That is because an inverted yield curve has been a rather reliable predictor of a future recession. Recession fears may make the Fed’s task of stabilizing prices harder, as painful higher interest rates fight inflation underpinned by supply constraints. The central bank must guard against slowing demand too much, risking “stagflation,” a period of high inflation and slowing economic growth (stagnation), accompanied by rising unemployment.
Conclusion: With concerns about a more-hawkish Fed looking somewhat priced into the market and bond prices continuing to fall, we believe a well-diversified portfolio of high-quality equities is the best near-term investment strategy.