Week in Review: May 27, 2022

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Week in Review: May 27, 2022

The Fed Confirms Front-Loading 50-bp Rate Hikes for June and July 

 

Market summary

The S&P 500 and Nasdaq enjoyed big weekly gains, breaking a seven-week streak of declines. The S&P 500 gained the most in a week since November 20, 2021. Each sector rallied higher, led by cyclical groups such as retail and autos. Growth outperformed Value this week. Treasuries firmed and the curve steepened, with the two-year yield under 2.5%. The dollar index weakened this week.

This week   

The minutes from the Federal Open Market Committee (FOMC) May 3-4 policy meeting emphasized that the Federal Reserve (the Fed) sees the need to continue with 50-bp rate hikes at the next few meetings to reduce inflationary pressures (see Figure 1). The FOMC minutes from the May 3-4 policy meeting did not offer any surprises. The FOMC minutes indicated that they will reassess our economic and financial standing before deciding whether to pause or slow the magnitude of interest rate hikes later this summer.  

The Fed minutes addressed inflation’s uncomfortably high level, and in their view inflation will stay higher for longer than they had anticipated. The FOMC minutes illustrated that Fed officials are rapidly raising rates to at least a neutral level to squash inflation risks that are exacerbated by continuing supply-chain issues. At the same time, demand remains high due to robust consumer spending, which is fueled by a very tight employment market, and strong household balance sheets. Russia’s invasion of Ukraine, which elevated oil prices, and China’s zero-COVID policy, which further stressed supply chains, are key uncertainties that the Fed has no control over. While the Fed cannot fix the supply-chain disruptions, it can slow demand by continuing to raise rates.  

The FOMC also discussed that balance sheet runoff is slated to commence on June 1. Each member supported plans for quantitative tightening and potentially selling mortgage-backed securities after quantitative tightening is “well under way,” likely around 2023. The Fed expressed confidence in the economy’s ability to withstand these policy changes, supported by the tight labor market and consumer savings. Fed officials also assessed that their forward guidance was having the intended effect on market expectations in a way that led to a desired tightening in broad financial conditions.  

A combination of less demand from consumers and higher input costs has led to weaker profit margins for corporations. Profit margins declined for the second straight quarter to 11.8% of the GDP, while corporate profits declined by $66 billion after soaring to $2.94 trillion in Q4. We expect the compression in margins (from their historically high level) to continue as wage growth stays elevated, productivity gains erode and companies’ pricing power decreases. 

The first economic contraction since the 2020 recession ended was slightly worse than initially reported as real GDP fell by a revised -1.5% in Q1. Inventories caused a larger drag than expected, and large downward revisions in residential investment were slightly offset by some upward revisions in consumer spending. Residential investment growth was revised lower and barely grew in Q1. We are already seeing cracks in the housing market as recent Fed rate hikes have dampened housing affordability. New home sales declined 16.6% in April, the steepest one-month decline since July 2013. This sharp decrease in new home sales is evidence that the Fed hiking rates higher is having its intended effect of slowing housing demand. We believe housing demand will remain low as the Fed continues to hike rates, making borrowing more expensive (see Figure 2).

Going Forward

Markets will continue to face more downside risks as economic growth slows, inflation remains high and rates move higher. Equity and bond volatility will stay elevated as economic and geopolitical uncertainty persist. Given the aggressive Fed and slowing growth, we expect credit spreads will continue to be volatile and leak wider. We look to rebalance portfolios with lower entry points as we see upcoming periods of weakness to deploy cash back to risk assets. We suggest prioritizing efficient profitability, durable sales growth and shareholder yield. Within equities, we continue to prefer U.S. Large Caps, since economic growth is slowing in Europe and COVID policies hurt manufacturing in China. In fixed income, we remain short duration and higher quality in our positioning.  

 

THE WEEK AHEAD

  • May’s Conference Board consumer confidence is expected to decline to 102.5 and will be released on Tuesday.  
  • April’s JOLTS Job Openings are expected to decline to 11,400 and will be released on Wednesday.  
  • May’s ISM Manufacturing index is expected to decline to 55 and will be released on Wednesday.  
  • May’s Nonfarm Payrolls are expected to grow to 325,000 and will be released on Friday.  
     

Figure 1: Fed funds futures (percentage, as of 5/27/2022)

 fed funds

Source: Bloomberg, Federal Reserve Bank, First Republic Investment Management.

Figure 2: MBA U.S. FRM 30-year contract rate vs. U.S. new home sales (as of 5/27/2022)

 mortgage vs new
Source: Mortgage Bankers Association, National Association of Realtors, Bloomberg, First Republic Investment Management.
 

Market Returns (USD) as of 5/26/2022

1-Week

Quarter-to-Date

Year-to-Date

1-Year

Global Equities

MSCI All Country World

 
3.2% -9.8% -14.7% -8.3%

S&P 500


4.0% -10.2% -14.3% -1.9%

Dow Jones Industrial Average


4.5% -5.6% -9.5% -3.1%

NASDAQ


3.1% -17.3% -24.7% -14.0%

Russell 2000


3.5% -11.1% -17.7% -17.4%

First Republic Founders Index

 
1.9% -19.6% -30.0% -30.6%

Russell 1000 Equal Weighted


3.9% -6.8% -7.9% -2.8%

MSCI EAFE

 
2.8% -7.1% -12.6% -11.4%

MSCI Emerging Markets

 
1.0% -10.0% -16.3% -22.5%

Fixed Income

ICE BofAML Municipals 1-10 Year A-AAA 

1.6% -0.8% -5.4% -5.2%

Bloomberg Barclays Intermediate Government/Credit

0.7% -1.0% -5.5% -5.9%

Bloomberg Barclays High Yield Bond

2.8% -4.0% -8.6% -5.8%

Market Levels

Thursday

Week Ago

Year End

Year Ago

S&P 500


4057.84 3900.79 4766.18 4195.988

Dow Jones Industrial Average

 

32637.19 31253.13 36338.3 34323.05

10-Year U.S. Treasury Yield (Constant Maturity)

2.75% 2.85% 1.51% 1.57%

Gold ($/oz)


$1,850.58 $1,842.08 $1,821.90 $1,896.51

Crude Oil ($/barrel)


$114.09 $109.89 $75.21 $66.21

U.S. Dollar / Euro ($/)


1.07 1.06 1.14 1.22

U.S Dollar / British Pound ($/£)


1.26 1.25 1.35 1.41

Japanese Yen / U.S. Dollar (¥/$)


127.33 127.4 115.16 109.04

Bitcoin Futures ($/XBT)

 
$29,315.00 $29,945.00 $47,977.03 $38,545.00