Global Policy Tightening: Headwinds Rising
The second quarter will undoubtedly feature an acceleration in the trend of higher central bank policy rates
The US Federal Reserve will also begin reducing the size of its balance sheet
People are not confident and investor sentiment is souring despite steadying oil prices and a bounce in stocks
Traders had their hands full in the first quarter. On the bright side, higher volatility and significant intraday swings across many asset classes might have felt like being a kid in a candy store to those of the risk-seeking ilk. Stocks endured a decent correction and V-shaped recovery, bonds had their worst quarter in decades, commodities soared (with many limit-up days in the ag space), and crypto ended March strong. The US Dollar was up slightly while the Euro and Yen dipped.
Stepping Up Tightening Cycle
Where do we go from here? Sure, April is gleefully known as one of the best months of the year for the S&P 500 historically, but, at the same time, we are in a mid-term election year which have notoriously featured more volatility and downside price action through much of Q3. We are not out of the woods by any stretch.
The macro backdrop is also fraught with headwinds considering that consumers may be pressured by continued high inflation, the Fed is likely to hike rates nine times this year, and GDP growth around the world is decelerating. An inverted Treasury yield curve, while it might be noise more than anything, underscores the risk of a looming recession.
Bankers Embarking on Hikes
So here we are in Q2—fully in the midst of a globally coordinated effort to hike rates and tighten credit conditions. It was just two years ago when central banks around the world were slashing interest rates and enacting larger-than-ever asset purchases. That helped fuel one of the most crippling inflationary periods in decades (of course, other contributing factors being supply chain issues and the recent Russia invasion event).
Last year alone, there were 123 policy rate increases across 41 central banks. Q1 featured another 67 hikes. By the way, the FOMC is expected to announce quantitative tightening at next month’s meeting. No doubt, monetary policy is a huge headwind for the balance of 2022.
Featured Chart: Central Bankers’ Policy Game is Tight!
Credit Markets Tighten, People Are Displeased
But everyone knows interest rates are on the rise. That’s probably mostly discounted into markets at this point – consider the US 2-year Treasury rate is near 2.5%. The market has nearly priced-in 10 hikes already (though the 3-month Treasury bill yield is still quite low).
What’s not talked about as much could be a bigger story as we navigate the second quarter – worsening/tightening financial conditions. With higher rates comes more uneasiness to extend loans. Just look at the latest US 30-year fixed-rate mortgage figure – near 4.9%.
That’s about 250bps above the benchmark 10-year Treasury note yield (a wide spread by historical averages). Moreover, food and energy prices have surged in the last two years, putting a major squeeze on folks’ discretionary income. People are not happy about these trends (just look at recent consumer confidence and investor sentiment readings).
Our Quarterly Strategy Pack outlines more of our core views. These outlooks include a review of the macro picture, market analysis, and our asset allocation return outlook (revised as of March 31).
Bottom Line: While stocks have bounced sharply from their mid-March lows, many headwinds remain. Not the least of which is a global effort to whip inflation by hiking rates and tightening credit conditions. We assert that equities are left in a vulnerable position.
Over the coming weeks, we’ll analyze where investors might consider positioning themselves now that commodities have run up huge, bonds are seeing intense bearish momentum, and stocks are back to lofty levels. Our actionable weekly reports help investors manage risk in this treacherous and volatile year.
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