Equity and bond prices continued to retreat during June, capping a dismal quarter for investors. Key domestic and international economic statistics increasingly pointed to a global slowdown in growth as the second quarter progressed and by the end of the period, the US was on the verge of a declared recession.
Stock and credit markets were buffeted throughout the quarter by steep price declines, short but sharp recoveries followed by renewed downturns carrying prices to new lows. International and Emerging Markets followed suit. Performance of representative equity benchmarks for June, the second quarter, and 2022 to date are shown below.
The prospect of slowing corporate earnings growth during the second half of the year as P&L statements are impacted by inflation, slumping consumer demand, and higher borrowing costs have augmented investor pessimism. As the quarter ended, a downturn by commodity prices and rising new claims for unemployment insurance seemed to confirm this year’s downbeat tone.
It is always important to remember that markets look ahead. The economic statistics potentially presaging a slowdown have been foreseen by the collective vision of market participants. Equities have been in a general downturn since November 2021, when the last highs were posted by many important equity benchmarks. In other words, what is unfolding now and likely through the second half of this year has likely been discounted by the equity market weakness that has impacted values this year.
The Federal Reserve began its tightening program during the second quarter, hiking the Fed Funds rate to dampen economic demand. Higher rates were supplemented by a gradual reduction of assets held on the Fed balance sheet. The net effect of these actions was to increase bond market volatility and to push yields in the US Treasury and corporate credit markets significantly higher. The Fed has left little doubt that further increases in short term rates lie ahead.1 Futures markets are currently expecting at least two additional Fed Funds hikes, ¾% in July to a range of 2.25%- 2.50% and a further ½% or ¾% in September.
June’s inflation indexes, which will be reported in mid-July, will doubtless be integral to the Fed’s decision making. US Treasury yield curves on the dates indicated below illustrate the sharp increases in borrowing costs since the end of 2021. Note the current inversion with the 2-year yield above the 5 and 10 year levels. Despite a strong bond market rally in late June and early July, yields remain clustered around 3% with the 3-month Bill approaching 2%.
Source: Quotestream online quotation platform www.quotemedia.com
It is reasonable to assert that equity markets have already discounted continuing rate increases from the Fed and the developing economic slowdown. So, is the worst over? Now that recession appears imminent will stocks begin to recover lost ground? Will the Fed reverse course if unemployment rises? Of course, answers are unknowable, but some nascent signs could well be sowing the seeds of the next bull market.
The genesis of developing global economic contraction and the inflation that has gripped consumers over the past 12+ months has clearly been expensive oil. Energy costs associated with production and transportation have impacted a wide spectrum of commodity prices, as consumers worldwide are painfully aware.
While probabilities remain elevated that the Fed has not finished raising short term interest rates, consumer demand is falling away due to sharply higher costs for virtually everything required to survive from day to day. In the supply/demand equation, the demand destruction widely predicted to result from higher borrowing costs and rising prices is underway.
The Fed’s anti-inflation vendetta is effectively taking a blunt instrument to the economy to crush demand as it employs the only means at its disposal: draining the economy’s liquidity through higher interest rates and slower money supply growth.
The second half of 2022 is going to feature negative economic developments but as noted above, markets look ahead.
1 “Minutes of the Federal Open Market Committee, June 14-15, 2022,” www.federalreserve.gov, July 6, 2022. 2 “WEST VIRGINIA ET AL. v. ENVIRONMENTAL PROTECTION AGENCY ET AL.,” www.supremecourt.gov, June 30, 2022. 3 Ibid.
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