Market rebound reflect interested, yet nervous, investors

Thoughts

• Equity markets staged an impressive rebound, delivering the best week since November 2020, (S&P 500® Index up 6%), with four-straight days with gains of over 1%. Markets were primed for a rally given the oversold conditions, supported by optimism for a ceasefire in Ukraine, easing commodity prices, and supportive comments from China on the economy and markets. The S&P 500 cut the yearly loss by half to 6%, currently showing a gain in March despite intense volatility that has seen 1% directional moves in 12 of the past 18 sessions, with eight greater than 2%. It feels even more volatile against the backdrop of 2021, as 1% moves have occurred in half of the trading days this year, compared with just 21% last year.
• Interest rates are in focus following the FOMC raising the Federal Funds rate by 0.25% last week. The spread between the 10-year and 2-year Treasury yields has narrowed to tightest level since March 2020 at 0.19%, down from 1.30% last October. An inverted yield curve (long rates lower than short rates) is a strong predictor of a recession. Warning indicators in the bond market, including credit spreads, commercial paper spreads and the TED spread are all wide, but far below levels from the early stages of the pandemic.
• Following the strongest week the markets have seen since November 2020, investors are reminded of the ‘tug of war’ between fundamentals of the markets, such as earnings, economic growth and the consumer indicators, and externalities such as geopolitics, the Fed’s interest rate hike and COVID-19. Before last week, the externalities were proving to be stronger; however, the markets are now showing favor to the fundamentals and providing a positive outlook that will set the stage for a market rally.

News

• Ceasefire negotiations continue between Russia and Ukraine despite continued missile strikes this weekend on Kyiv. There are reports that President Putin will use recent territorial gains to force Ukraine to commit to neutrality, demilitarization, and protection of the Russian language. Ukrainian President Zelensky has called with direct talks with Putin, though it is unclear if those will occur. President Biden will travel to Europe this week for an extraordinary NATO summit to discuss sanctions against Russia, including a potential oil embargo.
• The FOMC voted to raise the Fed Funds rate by 0.25% following Wednesday’s meeting, triggering the “lift-off” of the rate cycle (see page 3 for detail). The “dot plot” indicated an aggressive path forward, with hikes expected at each of the remaining six meetings in 2022, four more than were signaled in December. St. Louis Fed President said the FOMC should have raised rates by 0.50%, brought the Fed Funds rate to 3.0% by year-end, and implemented a plan to reduce the Fed’s balance sheet given historic levels of inflation. Fed Governor Waller said the Fed should consider 0.50% moves in future meetings depending on the direction of geopolitical events. The Fed Futures curve embeds a greater than 50% chance of a 0.50% hike at the May meeting and an 82% chance of eight-or-more hikes this year.
• Markets in China are rebounding from weakness due to another COVID lockdown and tension between the U.S. and China about ADR listings, with a 6% rally from Tuesday’s low. China state media says sound economic fundamentals, pro-growth policies make yuan assets attractive to foreign investors. President Biden is set to speak with China’s President Xi following signs that China is closer to supporting Moscow’s invasion of Ukraine, including offsetting sanctions. China is seeing its largest COVID outbreak since the initial stages, challenging the “zero-COVID” policy, with Xi now saying that “China aims for maximum prevention while minimizing the impact on economic and social development.” This includes easing restrictions for factories in the tech hub of Shenzhen, potentially alleviating the supply chain impact.

What to Watch

• Fed policy will continue to be in focus this week, with Chair Powell giving a speech to the National Association of Business Economics on Monday. Economic data include new home sales on Wednesday, PMI data and durable goods on Thursday, and the University of Michigan reading on consumer sentiment and pending home sales Friday.