Equity markets paused following an impressive recovery, with the S&P 500® Index losing roughly 1% for the week. Investors have begun to refocus their attention from externalities (COVID, geopolitics) to fundamentals (economy, interest rates, profit margins), which could lead to more predictable and less emotional trading. Value indexes have reasserted control, with the Russell 1000® Value Index outperforming the Russell 1000® Growth Index by roughly 11% (-1% vs. -12%) this year.
Interest rates continue to surge, with the 10-year Treasury yield hitting a fresh three-year high at 2.75%. In the past 20 years, there have only been 10 weeks that surpassed the 0.33% move in the 10-year yield. The spread between the 10-year and 2-year has “uninverted,” though the curve remains extremely flat between the 3-year and 30-year. Bond indexes have experienced their most significant drawdown since 1981, with the Bloomberg US Aggregate Bond Index dropping over 9% since August of 2020 and over 7% this year. Oil prices have eased, with the lockdown in China expected to limit demand.
Investors may be tempted to react to tomorrow’s likely shocking CPI number, but they would be wise to take a breath. The number will be eye opening, but not market moving. Markets have anticipated these high inflation readings for months. The real question for investors now is, will inflation peak this spring as anticipated, or will it persist at historic levels longer than anticipated? Expect markets to react negatively if the April and May CPIs readings are stubbornly above 8%.
Fedspeak has become increasingly hawkish, with noted dove, Fed Governor Brainard, suggesting the Fed should begin reducing the balance sheet at a “rapid pace.” Noted hawk, St. Louis Fed President Bullard said the bank may be “behind the curve,” suggesting the Fed Funds rate should get above 3% by the end of the year, versus the median of the “dot plot” at less than 2%. Investors continue to bet on 0.50% hikes at the next two meetings, with the odds embedded in the curve at nearly 90%, including a one-in-three chance that one of the meetings has a 0.75% hike.
Inflation will continue to drive markets this week, with a reading on consumer price inflation on Wednesday and producer price inflation on Wednesday. CPI is forecast to hit a fresh 40-year, with a consensus estimate of 8.4% from a year ago, driven by energy, food, and used cars. Estimates are for March to be the peak in the cycle, though the pressures will remain elevated through the end of the year. Despite headwinds, consumer demand continues to drive economic growth, with the NY Fed’s Weekly Economic Index suggesting the economy is growing at a 5% pace. Google mobility data shows time away from home is at the best level since the early stages of the pandemic. Global financial conditions, however, have tightened to a level not seen since the end of the financial crisis, per Goldman Sachs data.
Earnings season unofficially begins next week with the large banks kicking things off. The current consensus expects growth of roughly 5%, down from the 7% expected at the beginning of the year. This represents a sharp deceleration from the 31% growth in the fourth quarter, as the Omicron slowdown, supply chain issues, and geopolitical concerns weigh on profitability. Results for the quarter and commentary around future quarters will focus on the balance between cost pressures and availability of labor and materials against pricing power.
What to Watch
Inflation will be the primary focus of investors this week, with the March CPI on Tuesday and PPI on Wednesday. Other notable economic releases include NFIB Small Business on Tuesday, retail sales and consumer sentiment on Thursday, and industrial production on Friday. Markets are closed Friday in observation of Easter.
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