Hope Floats: July 2022 Markets
Markets staged a comeback in July as U.S. equities posted their best monthly gains since November 2020. The S&P 500 equity index rose 9.11%, the tech-heavy Nasdaq finished up 12.4%, while the Dow posted gains of 6.7%. Gains were fueled by better-than-expected financial results from America’s biggest companies, as well as bets that the Fed might dial back monetary policy tightening sooner than expected.
While inflation numbers continued to run hot for June, we are starting to see prices come down. The S&P GSCI agriculture index, gasoline costs, and used car prices are all falling, which could provide some relief. Goods in demand since the pandemic, like appliances and furniture, should see less inflation, or even price declines, in the coming months.
Reaching Neutral Rates
Once again, Federal Reserve policy took center stage as policymakers raised the benchmark U.S. interest rate 0.75% (75 basis points) to a range of 2.25% to 2.5.
Fed Chair Jerome Powell noted that “ongoing increases” would be appropriate depending on how the economy performs, though he stopped short of providing guidance on the magnitude of upcoming hikes. However, Powell’s statement also said, “As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.”
In unscripted remarks, Powell noted that interest rates have reached a “neutral level.” Neutral rates refer to policy rates that are neither accommodative nor restrictive to the economy. According to former chief executive of Pimco and Bloomberg columnist Mohammad El-Erian, this suggests that the Fed believes it has already done the bulk of what is needed to tighten monetary policy to deal with high inflation.
Markets cheered the remarks, and the benchmark S&P 500 gained 2.6% on the day of the FOMC meeting.
Rate projections suggest that the Fed may start cutting rates again in 2023. What would trigger rate cuts after a year of aggressive hikes? The main cause would be a recession and slower growth, and the Treasury market is already flashing warning signs of possible risks ahead.
Chair Powell was questioned about whether the U.S. economy was either in or on the cusp of a recession—an idea he rejected because U.S. firms continue to hire over 350,000 more workers each month.
The common short-hand definition of recession is two consecutive quarters of negative economic growth. Data showed U.S. gross domestic product (a measure of economic activity) contracting for the second consecutive quarter between April and June.
However, the actual determination comes from the National Bureau of Economic Research (NBER), which defines a recession as a “significant decline in economic activity that is spread across the economy and that lasts more than a few months.” Other criteria used by a dedicated NBER panel include the depth, diffusion and duration of the decline.
According to the National Economic Council, the U.S. added more than a million jobs in the second quarter, and we’ve never had a U.S. recession where the economy didn’t lose jobs.
Whether or not we are in a recession, markets barely reacted to the GDP news. As Goldman Sachs notes, “credible and transparent policy measures have lessened the risk of a severe Fed-induced downturn, and any recession due to Fed overtightening will likely be short and shallow.” This month, markets were able to focus on the positive, especially after strong tech earnings.
Heading Into Fall
We’ve previously discussed the tightrope act the Fed needs to walk with rate hikes while balancing price and financial stability. Unexpected inflationary shocks like the ongoing Russia-Ukraine war and Chinese Covid lockdowns continue to muddle the picture.
According to Blackrock, policy trade-offs are much more difficult to assess now, meaning central banks will likely veer between favoring economic activity over inflation and vice versa. The end result could be higher inflation and shorter economic cycles.
The dilemma for markets is that equities suffer if rate hikes trigger a slowdown, but if policymakers tolerate higher inflation, bond prices fall. Either way, Blackrock sees higher risks baked into market prices across the board.
It is our view that maintaining discipline and a level head will be critical to navigating this period—just as we believe they’ve been critical for the past couple of unprecedented years. If you have any questions about your strategy or market news, please don’t hesitate to reach out to us. We’re always happy to discuss!
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The Bloomberg Barclays U.S. Aggregate Bond Index measures the investment-grade U.S. dollar-denominated, fixed-rate taxable bond market and includes Treasury securities, government-related and corporate securities, mortgage-backed securities, asset-backed securities and commercial mortgage-backed securities.
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