markets & economy | May 13, 2022
Global Markets Weekly Update
Fading hopes for a soft landing punish stocks
Stocks recorded another week of losses, as investors appeared to grow increasingly skeptical that the Federal Reserve will be able to achieve a “soft landing” for the economy by raising rates enough to tame inflation without causing a recession. The Cboe Volatility Index (VIX) remained elevated but slightly below its recent intraday high on May 2. T. Rowe Price traders noted high trading volumes in exchange-traded funds, indicating high levels of hedging activity. Many cryptocurrencies plunged in value, further suggesting a strong risk-off environment.
It marked the sixth consecutive weekly decline for both the S&P 500 Index and the Nasdaq Composite and the seventh for the Dow Jones Industrial Average—the longest stretch for the latter since 2001, according to The Wall Street Journal. At its low point on Thursday, the S&P 500 was down nearly 18% from its peak, well into correction territory but just above the -20% performance threshold that typically defines a bear market. The benchmarks pared some of their losses on Friday, helped by a rally in Tesla shares after CEO Elon Musk tweeted that his deal to buy Twitter—partly funded by sales of a portion of his considerable stake in the electric car maker—was “on hold.”
Our firm’s traders noted that five themes seem to be behind the market’s continued declines: the Fed’s accelerated pace of monetary tightening, persistently high inflation data, worries about slowing growth, disruptions caused by China’s strict COVID-19 lockdowns, and Russia’s invasion of Ukraine (see Europe and China sections below).
Inflation moderates less than hoped in April
Negative signals on each theme arguably emerged during the week, but it may have been Wednesday’s inflation data that weighed the most on sentiment. Headline consumer inflation fell back a bit from March’s pace but not as much as expected, rising 8.3% year over year versus consensus estimates of around 8.1%; likewise, core consumer inflation (excluding food and energy) pulled back less than expected to 6.2% versus 6.0%. Core producer prices rose a bit less than expected in April, but March’s monthly gain was revised higher to a record 1.2%.
Particularly worrying to investors may have been the 0.7% monthly surge in consumer prices for services (less energy services), indicating that inflationary pressures were moving beyond manufacturing and energy supply chains and becoming more broadly embedded in the economy. Airline fares jumped 18.6% over the month, for example, the largest increase on record.
The University of Michigan’s preliminary survey of consumer sentiment in May, released Friday, indicated the steep toll that inflation was taking on Americans’ confidence in their finances. The survey’s sentiment gauge fell much more than expected (to 59.1 versus consensus estimates of roughly 64) and hit its lowest level in 13 years. Survey respondents reported the worst conditions for buying appliances and other durable goods since researchers began asking the question in 1978.
U.S. Treasury yields fall, but credit spreads widen
The smaller-than-expected decline in consumer inflation caused a brief jump in the yield of the benchmark 10-year U.S. Treasury note on Wednesday, but it ended sharply lower for the week as a whole and fell back below 3.0%. (Bond prices and yields move in opposite directions.) Our traders observed signs that the typical inverse correlation between equities and Treasuries may be returning as stock prices fell meaningfully during the week.
The broad tax-exempt debt market traded lower over most of the week despite the rally in U.S. Treasuries. Along with an uptick in new issuance, continued outflows from municipal bond mutual funds posed a strong headwind to market performance, although our traders reported that cash flows into exchange-traded funds provided some support to the front end of the yield curve. According to our traders, new offerings were forced to re-price to higher yields, reflecting investor demands for higher-coupon structures.
Our traders observed an uptick in overnight demand from Asia for investment-grade corporate bonds, with the demand focused on higher-quality, longer-maturity credits. However, corporate credit spreads widened over the week alongside moves lower in the equity market and broader risk-off sentiment. Against the weaker macro backdrop, primary issuance was relatively subdued, with the weekly total falling short of expectations. Weakness in the high yield market reflected the pullback in equities, and credits from companies that missed earnings and/or revised guidance lower were notable underperformers. The primary market was quiet as most issuers remained on the sidelines amid the heightened volatility.
Bank loans followed broader risk markets lower. Overall, lower-quality credits and out-of-favor sectors continued to underperform, but our traders also noted that some investors continued to rotate out of loans while looking for attractive values in high yield bonds. Earnings season was another driver of trading activity, as companies that beat expectations generally performed in line with the broader market, whereas companies that fell short of expectations were punished.
|Index||Friday's Close||Week's Change||% Change YTD|
|S&P MidCap 400||2,430.83||-50.12||-14.47%|
This chart is for illustrative purposes only and does not represent the performance of any specific security. Past performance cannot guarantee future results.
Source of data: Reuters, obtained through Yahoo! Finance and Bloomberg. Closing data as of 4 p.m. ET. The Dow Jones Industrial Average, the Standard & Poor’s 500 Stock Index of blue chip stocks, the Standard & Poor’s MidCap 400 Index, and the Russell 2000 Index are unmanaged indexes representing various segments of the U.S. equity markets by market capitalization. The Nasdaq Composite is an unmanaged index representing the companies traded on the Nasdaq stock exchange and the National Market System. Frank Russell Company (Russell) is the source and owner of the Russell index data contained or reflected in these materials and all trademarks and copyrights related thereto. Russell® is a registered trademark of Russell. Russell is not responsible for the formatting or configuration of these materials or for any inaccuracy in T. Rowe Price's presentation thereof.
Shares in Europe rebounded from earlier weakness to finish higher, despite ongoing concerns about inflation, tightening monetary policy, and the economic outlook. In local currency terms, the pan-European STOXX Europe 600 Index ended 0.83% higher. The main market indexes advanced. Germany’s Xetra DAX Index climbed 2.59%, Italy’s FTSE MIB Index tacked on 2.44%, and France’s CAC 40 Index added 1.67%. The UK’s FTSE 100 Index ticked up 0.41%.
Core eurozone government bond yields fell amid a broad developed market bond rally led by U.S. Treasuries. Peripheral eurozone and UK government bond yields largely tracked yields in core markets.
Finland poised to decide on joining NATO; Russia threatens retaliation
Finland’s President Sauli Niinistö and Prime Minister Sanna Marin backed the country joining NATO as soon as possible. Finland is expected to formally announce its decision on Sunday. Sweden indicated it would announce a similar decision on the same day. The Russia foreign ministry threatened unspecified “military-technical” retaliation. Previously, Russian officials have warned that they might place nuclear weapons in the Kaliningrad enclave on the Baltic coast.
Russia sanctions EU energy companies, cuts off gas
Russia imposed sanctions on European Union (EU) energy companies, including Gazprom Germania, which was taken over by Germany last month. Russia’s state-owned gas company Gazprom then said it would cut shipments to Europe via the Yamal pipeline, which runs through Poland to Germany. Earlier, Ukraine’s pipeline operator stopped flows through one of the two pipelines transporting Russian gas through the country to Europe, blaming interference by Russian armed forces.
Meanwhile, EU diplomats could drop proposals to ban Russian oil temporarily while moving ahead with other measures that would be part of a sixth package of sanctions, according to the POLITICO website, citing diplomats. The ban is opposed by countries that rely on Russian oil supplies, including Hungary. Separately, the EU dropped a plan to stop its shipping industry from carrying Russian crude oil after objections from Malta and Greece, the Financial Times newspaper reported.
ECB’s Lagarde hints at potential rate increase in July
European Central Bank (ECB) President Christine Lagarde said in Slovenia that the ECB’s bond-buying program could end "early in the third quarter” and be followed by a rate increase "only a few weeks" later. The comments are the clearest sign yet from Lagarde that the ECB could move on rates sooner rather than later. Since the April policy meeting, a growing number of policymakers have appeared to lend their backing to increasing interest rates in July. Joining their ranks during the week were German central bank President Joachim Nagel, who said he “will advocate a first step normalizing ECB interest rates in July,” and Frank Elderson, the newest member of the executive board, who said that the ECB could consider raising rates in July “dependent, as always, on the incoming data.”
UK economy unexpectedly shrinks
The gross domestic product of the UK unexpectedly contracted 0.1% in March, after stagnating in February, due mainly to a decline in service sector activity. The economy grew 0.8% in the first quarter, but this was below the 1.0% expected by economists and the 1.3% expansion that occurred in the fourth quarter of last year.
Japan’s stock markets fell over the week, as expectations that the U.S. Federal Reserve would aggressively tighten monetary policy, concerns about slowing global growth, and the economic implications of the war between Russia and Ukraine continued to weigh on risk appetite. Broadly positive earnings developments and renewed expansion in service sector business activity lent some support, however. The Nikkei 225 Index lost 2.13%, and the broader TOPIX Index was down 2.70%. The yield on the 10-year Japanese government bond finished the week broadly unchanged at 0.24%, while the yen strengthened to around JPY 128.12 against the U.S. dollar, from about JPY 130.41, although it remained at very depressed levels.
BoJ reiterates commitment to aggressive monetary easing
Against the backdrop of monetary accommodation being reduced in the U.S. and Europe, and amid some speculation that the Bank of Japan (BoJ) should also scale back its aggressive monetary easing, BoJ Governor Haruhiko Kuroda reiterated the central bank’s commitment to its current monetary policy stance. Japan’s economic growth has not recovered to pre-pandemic levels, and the expected rise in prices in the short run—driven by energy costs—will lack sustainability, according to Kuroda, with no sharp rise in medium- to long-term inflation expectations. Given current developments in economic activity and prices in Japan, the BoJ considers it necessary to continue with aggressive monetary easing to support the economy’s post-pandemic recovery and to achieve the central bank’s price stability target of 2% annual inflation.
Japan agrees on ban of Russian oil imports with other G-7 nations
Against the backdrop of the war between Russia and Ukraine, Japan’s government agreed in principle on a ban of Russian oil imports with other Group of Seven (G-7) developed nations. Prime Minister Fumio Kishida stressed the importance of G-7 coordination. However, he emphasized that it had been a difficult decision given the resource-poor country’s dependence on Russian fuel and that Japan will take its time to reduce or suspend imports as part of a phased approach to minimize the negative impact on people’s lives and business activities. Kishida did not offer a specific road map on the import ban. The government does not intend to abandon its stakes in two important oil and liquified natural gas projects on the Russian island of Sakhalin north of Japan, given their extreme importance for Japan’s stable energy supply.
The government also announced a strategic digital partnership with the EU following a meeting in Tokyo between Kishida and European Commission President Ursula von der Leyen. The EU and Japan agreed to cooperate increasingly on developing digital technologies, cybersecurity, and artificial intelligence.
Chinese stocks rallied as a fall in coronavirus cases and reassuring comments from the securities regulator lifted investor sentiment. The broad, capitalization-weighted Shanghai Composite Index added 2.7%, and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, rose 2.1%.
The China Securities Regulatory Commission aims to increase the participation of institutional investors in the country’s stock markets and expand the investible universe of the exchange link with Hong Kong, according to an interview carried on state media with Vice Chairman Wang Jianjun.
The yield on the 10-year Chinese government bond declined to 2.834% from 2.848% after the People’s Bank of China (PBOC) reiterated pledges to maintain reasonably sufficient liquidity and stable credit growth in its first-quarter monetary policy report.
The yuan weakened to CNY 6.80 per U.S. dollar from CNY 6.67 a week ago. The currency has fallen more than 5% against the greenback in the last three weeks amid rising U.S. interest rates, the Russia-Ukraine war, slowing domestic growth, and speculation that the central bank will act to slow its depreciation.
The yuan’s slump is an unwelcome development for issuers of dollar bonds, many of which are in the debt-laden property sector and struggling with slowing sales, weak prices, and refinancing pressures. The property sector’s liquidity crisis continued as Sunac China Holdings and Zhongliang Holdings became the latest developers to discuss debt solutions on their repayment obligations.
In economic readings, credit demand in April weakened as new loans fell to a worse-than-forecast CNY 645.4 billion yuan (USD 95.14 billion) from CNY 3.13 trillion in the previous month, as lockdowns in cities across the country hit economic activity. Export growth in U.S. dollar terms plunged to 3.9% year on year in April from 14.7% in March, while import growth in April was flat over a year ago and roughly unchanged from March’s pace. Both sets of data were higher than economists’ estimates.
On the inflation front, factory gate inflation jumped a higher-than-expected 8% in April following the previous month’s 8.3% increase. Consumer inflation rose at an above-expected 2.1% year-on-year rate and accelerated from March’s 1.5% pace. Analysts said that higher fuel and food prices drove the increases for the factory gate and consumer inflation readings.
Other Key Markets
Turkish stocks, as measured by the BIST-100 Index, returned about -1.6%. Turkish assets struggled amid weakness in U.S. and global equity markets. Turkey is a major importer of energy commodities, so financial markets were also hurt by upward pressure on oil and natural gas prices following news that Ukraine—Turkey’s neighbor across the Black Sea—was curtailing Russian natural gas flows through its country into Europe due to invasion-related interference from the Russian military.
T. Rowe Price sovereign analyst Peter Botoucharov notes that the Turkish lira has recently resumed its weakening trend—down about 4% versus the U.S. dollar over the last month, and down more than 10% in the year-to-date period through April 30—due in part to recent consumer price index (CPI) data showing year-over-year headline inflation approaching 70%. Even though real (inflation-adjusted) interest rates are deeply negative, Botoucharov does not expect the central bank to raise nominal interest rates in the near term.
In view of the slowing economy and lagging job creation, and the aim of President Recep Tayyip Erdogan’s regime to deliver growth prior to elections in June 2023, Botoucharov believes that the government and central bank remain committed to Erdogan’s “New Economic Program.” This is based on a highly stimulative monetary policy and an exchange rate that increases the competitiveness of Turkish exporters in world markets. The downside of these policies is higher inflation and a weaker lira.
Stocks in Brazil, as measured by the Bovespa Index, returned about 1.9%. Although global equity markets struggled, Brazilian equities held up fairly well amid reports that inflation in April was very close to expectations and that retail sales and service sector activity were better than expected.
T. Rowe Price sovereign analyst Richard Hall believes that the Brazilian economy has been recently going “sideways.” Household consumption has been solid, reflecting continued high credit growth, a recovering labor market, and fiscal stimulus measures. External demand has also been supportive, especially in agriculture, given higher global food prices. On the other hand, the mining sector has been disappointing, as heavy rains this year have limited Brazil’s ability to export iron ore at elevated prices. The key offset to various growth-supportive factors, however, is monetary policy tightening, with the benchmark Selic rate having increased by more than 1,000 basis points (10 percentage points) to 12.75% since March 2021. Despite these offsets, Hall believes that inflation—recently measured at a rate of more than 12% year over year—could remain high for some time, particularly if the central bank pauses its interest rate increases until after the elections in October.
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