- High inflation readings in the U.S. are causing high volatility in the markets as well as higher yields in fixed income.
- The Federal Reserve began raising interest rates in March in what is expected to be a series of rate increases to slow down inflation.
- Stocks rebounded during the month, with most sectors of the market higher.
The Russian invasion of Ukraine has caused a surge in global energy and commodity prices, sparking price shocks and threatening to derail the global economic recovery. Consumer inflation, which had been rising well before the crisis in Ukraine, has investors worried about the path of monetary policy this year as the Federal Reserve has committed to tighter conditions. The Consumer Price Index (CPI) has risen almost 8% over the past year, its highest level since 1982. These economic uncertainties and higher interest rates have caused volatility in markets for the first quarter of this year. After a challenging January and February, stocks bounced back in March with the S&P500 gaining 3.71%. Utilities (+10.36%), energy (+8.96%) and real estate (+7.79%) led the market higher for the month, while financials (-0.19%) was the only negative equity sector. Small cap stocks lagged their bigger counterparts while growth outperformed value in large cap stocks.
While high inflation, higher interest rates and the Ukrainian crisis are headwinds to risk-taking across the globe, Covid cases have been plunging and starting to become an afterthought. Many aspects of the US economy are getting back to pre-pandemic levels with supply chain issues beginning to ease. The labor market remains tight as 431,000 jobs were added in March, bringing the unemployment rate down to 3.62%. Higher inflation costs for workers should lead to higher wages in a tight labor market, further feeding inflation inputs.
The Federal Reserve raised the Federal Funds rate in March in their effort to slow down inflation. Many economists expect them to hike at each subsequent meeting by 25 additional basis points, although 50 basis points is not off the table. This is not an easy task as raising rates too quickly may choke off credit growth as higher rates mean higher financing costs which will slow down the economy. The Barclays Aggregate Bond Index, which includes Treasury, mortgage, and corporate bonds saw its fourth consecutive monthly decline in March. Higher market yields caused the index to drop 2.78% for the month and was down 5.93% in the first quarter. In addition, the yield curve inverted during the month, as 2-year Treasury yields exceeded 10-year yields. Traditionally longer duration assets have higher yields as they are more susceptible to changes in prevailing interest rates. A higher yield in shorter term securities of equal credit risk indicates that the market expects (or is obtaining protection from) lower rates in the future. Rates usually come down after the economy slows and the Fed begins the cycle over again. Investors should expect volatility in both equity and fixed income markets to continue until we have more clarity on inflation and the situation in Ukraine.
Sources: Morningstar Direct, Guggenheim, Wall Street Journal