Commodity pressures next hurdle for markets

Thoughts

• Investors flocked to safety, with gold and the U.S. dollar both hitting fresh 52-week highs, which is unusual given they tend to move in opposite directions. Volatility remains elevated, with the VIX near 34, and investor sentiment continues to collapse, with the CNN Fear & Greed Index at the lowest level since the early stages of the pandemic. Investors continue to be on edge due to the war in Ukraine, with the S&P 500® Index moving back into correction territory, leading several Wall Street strategists to cut their S&P 500 price targets. Futures improved Monday on word that Russian and Ukrainian diplomats will meet Thursday, and Russia would cease military action if Ukraine met their demands.
• Commodity prices had their largest gain in history last week, with the S&P Goldman Sachs Commodity Index adding 20% for the week, and more than 2% in each trading day. Crude prices have jumped to more than $120, a level only briefly exceeded in 2008 and up more than 60% this year on word that the U.S. is in talks to ban Russian imports. In addition to accounting for 10% of global oil, Russia is also a major producer of natural gas, agricultural commodities, fertilizers, copper, aluminum, and steel. Inflation expectations, as measured by the 5-year breakeven inflation rate, hit 3.2%, the highest pace on record dating to 2003.
• During periods of tremendous stress, the market tends to overweight large negative outcomes, even if those outcomes are unlikely. We likely won’t see a stabilization in the market until there are positive developments in Ukraine, but when that happens, the market should snap back quickly and intensely.

News

• Headwinds from war pressures and uncertain economic growth add to the complexity of the Federal Reserve’s policy path. Chair Powell was explicit in Congressional testimony that he will push for a 0.25% hike to the Fed Funds rate at the March 16 meeting, though he remains noncommittal beyond that. The spread between the 10-year and 2-year Treasury yields narrowed to the lowest level since before the pandemic at 0.24%, with a negative reading historically serving as a recession predictor. Other stress indicators, including the TED spread (the rate that banks lend to each other) and commercial paper spreads, rising to the widest level since the early stage of the pandemic. Outflows continue from bond funds, with high yield showing outflows for the seventh straight week and their largest since March 2020.
• Despite the continued challenges, economic metrics have stabilized, as COVID cases have dropped more than 90% from mid-January and deaths on a severe decline. The NY Fed’s Weekly Economic Index indicates growth of roughly 6%, while Google mobility data recovering. The Atlanta Fed’s GDPNow model indicated flat GDP in the first quarter versus the consensus of economists at 2% and the fourth quarter at 7.0%. The monthly payroll report showed a surge in hiring to 678,000 from 481,000 in January and an improvement in the unemployment rate, though wage growth of 5.1% is well below the rate of inflation.
• The International Monetary Fund warned that the war in Ukraine will have a “severe impact” on the global economy. Ukraine requested $1.4 billion in emergency funding as early as this week. Sanctions on Russian banks will severely restrict access to international reserves to support its currency and financial system. The IMF’s World Economic Outlook published in January forecast global growth in 2022 of 4.4%, 0.5% lower than the October prediction, driven by lower fiscal and monetary accommodation and continued supply chain shortages in the U.S. and COVID-related actions in China. Growth is forecast to slow to 3.8% in 2023.

What to Watch

• Developments in Ukraine will be the primary focus of investors, but inflation will be closely watched as well, with the report on CPI on Thursday. Other notable releases include NFIB Small Business on Tuesday, JOLTS job openings Wednesday, and consumer sentiment on Friday.