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It’s been a rough ride for investors as red ink has spilled profusely so far this year. The losses have been particularly acute in the bond market, which, ironically, is usually the refuge for investors seeking safety and stability when conditions get dicey. Not so this time. In the first quarter, holders of Treasury securities saw the value of their portfolios shrink by 5.6 percent, the worst performance for a quarter on record. The stock market also took it on the chin, as prices are down sharply since the end of last year, although they have rallied from the lows reached in the first week of March.
The Russian invasion of Ukraine is primarily a human tragedy, but the global economic costs can’t be ignored – and they are piling up. It’s unclear how long the war will go on; the longer it persists, the greater the toll on world economies. As it is, the conflict has put a crimp in economic activity and amplified inflationary pressures that were already stoked by pandemic-related supply shortages. That combination has led some to compare the looming economic environment with the stagflation of the 1970s, a decade that featured many years of sluggish growth, high unemployment and sharply rising prices.
It was another bad week for stocks, which tumbled for the seventh consecutive week and edged ever closer to bear-market territory. Since the end of last year, the S&P 500 is down 18 percent, which translates into about $14 trillion of destroyed wealth. That’s almost 60 percent of GDP. To paraphrase Senator Everett Dirksen, the prominent Republican leader of the 1960s, a trillion here a trillion there, and pretty soon you’re talking about real money. The last time the market fell this much, in late 2018, the Fed came to the rescue, pivoting away from its three-year rate-hiking campaign. The question is, will the Fed at some point step in to stop the bleeding again?
The inflation story continued to dominate headlines and stoke volatility in the financial markets this week. For a brief time, stocks flirted with a bear market, as the S&P 500 declined almost 20 percent from its nearby peak in early January, stopping just an eyelash short of that bear-delineating threshold on Thursday before rallying on Friday. Still, the index fell for the sixth consecutive week, something that hasn’t happened since 2011. The bond market fared only slightly better; the bellwether 10-year Treasury yield started the week a touch below the three-year high of 3.20 percent reached last week and slipped erratically below three percent by the end of the week.
According to the National Heart, Lung and Blood Institute (NIH), May is High Blood Pressure Education month. If the heart-palpitating events of the past week are any indication, the Institute has its work cut out for it. It’s hard to recall another week that generated as much drama or anxiety. That’s particularly so for investors whose pulses received some extreme shocks from wild gyrations in the financial markets, including two consecutive days – Wednesday and Thursday – when stock prices ended at least three percent higher or lower, something that hasn’t happened in more than two years. Market interest rates also moved sharply, but mostly in one direction – up, with the bellwether 10-year Treasury yield climbing decisively above the three percent threshold, ending the week at 3.14 percent, the highest since November 2018.
The soft landing crowd got a rude awakening this week when the Commerce Department reported that the economy contracted in the first quarter, the first downturn in GDP since the pandemic-induced recession in 2020. To be sure, the markets had no illusion that the annualized 1.4 percent setback meant the economy was in the throes of a recession. For one, the consensus of forecasters had already expected a soft reading for the first quarter, given the timid handover from late last year when Omicron sapped considerable strength from activity and supply shortages had a stifling effect on production. Our tracking models anticipated a growth rate of less than one percent.
Since 2011, the 10-year Treasury yield has pierced 3.0 percent on rare occasions – a few brief months in the fall of 2018 and one or two daily forays in late 2013. It moved precariously close to that threshold’s doorstep, trading at 2.96 percent on Thursday, before giving back some ground on Friday, but still surging nearly 60 basis points since the start of the month. Meanwhile, the stock market suffered a major blow this week, notching heavy losses punctuated by a plunge of nearly three percent in the major indexes on Friday. This pattern is counterintuitive, since the bond market is supposed to be a safe refuge for investors when losses on riskier assets, such as stocks, start to pile up.
The trillion-dollar (nominal) question of the week is whether the 8.5 percent inflation rate recorded in March marks the peak for the cycle. The consensus seems to think it is, if only for statistical reasons. Most notably, the so-called base effects will start to kick in this month as comparisons with the inflated prices of a year ago point to slower increases in coming months. Some help should also come from lower gasoline prices, as the decline in crude oil prices in recent weeks have already reduced the cost of filling up at the pump. By itself, that would have a major impact on the headline change in consumer prices, as surging energy prices accounted for nearly three-quarters of the 1.2 percent increase in the consumer price index between February and March – the steepest monthly increase in more than 15 years.
The bond market experienced an attack of the Federal Reserve Bs – Brainard and Bullard – whose hawkish comments accelerated the upward move in long-term Treasury yields this week. Both advocated a more aggressive response to galloping inflation, cementing the prospect of a 50 basis point increase in the Federal funds rate at the early May policy meeting. What’s more, St. Louis Fed president Bullard said he would like to see the rate go as high as 3.00– 3.25 percent over the second half of this year. For a market that had been pricing in about 100 basis points less, that’s all it needed to drive the 10-year Treasury yield up to a three-year high of over 2.70 percent on Friday, about 30 basis points higher than a week earlier.
With the calendar page turning to April, it’s with great pleasure that we say good riddance to the first quarter. To be sure, not all the news was bad. The Omicron variant vanished as quickly as it appeared, although it has birthed a subvariant that may yet prove troublesome if it follows the path seen in China and some other nations. But the good news on the domestic health front was overshadowed by a litany of downbeat developments that is casting a dark cloud over the start of the second quarter. The war in Ukraine has ushered in the worst humanitarian crisis since World War II, and the agony and suffering will persist long after a ceasefire is declared. Along with the human toll, the war is also wreaking havoc on the global economy, stoking inflationary pressures that were already raging under pandemic-related supply chain stresses and leading to sanctions that are curtailing energy, food and other critical resources that will slow, if not reverse, growth in nations heavily dependent on these inputs.