Markets Price in Aggressive Rate Increases
As investors weigh the impacts of the conflict in Ukraine, equity markets were mostly positive for the second consecutive week. We saw global markets (represented by the MSCI All Country World Index) up 1.2% and domestic stocks (represented by the S&P 500 Index) up 1.8%.
On Friday of this week, we will get a fresh labor market report. As is the case every month, the first Friday will bring us an updated unemployment rate from the U.S. Bureau of Labor Statistics. The February report showed an unemployment rate of 3.8%, which is approaching pre-pandemic levels.
The Federal Reserve has been very transparent that they expect interest rates to continue rising this year. As such, markets have quickly priced in those expectations with the 10-year Treasury bond going from a yield of 1.5% coming into 2022 up to 2.5% today. It’s become clear that the market has fully priced in these interest rate moves in a short period of time. One area we’re keeping an eye on is whether the yield curve, which shows the yield of government bonds at different maturity dates, inverts itself.
Historically, an inverted yield curve, which means shorter maturity bonds have a higher yield than longer maturity bonds, has some significance as a predictor of recessions. While that is certainly not our expectation given the current environment and economic data (which we still view as mostly positive), it would not surprise us to start seeing market headlines announce this phenomenon like what they did in 2019. Below is a chart showing the spread of 10-year bond yields minus the 2-year bond yield. As you can see it’s still positive but approaching zero.
As expected with interest rate expectations on the move, the cost of a 30-year mortgage continues to rise. As of late last week, the rate on a 30-year fixed mortgage was approaching 5%. While the supply and demand imbalance will keep home prices at elevated levels, higher rates will start to price out some buyers and will slow the demand for refinancing.
Despite all the talk about interest rates, inflation, and geopolitics, the good news about economic activity continues to slip through the cracks. Last week the IHS Markit’s report of both manufacturing and services activity rose to their highest levels in several months. Additionally, the Department of Labor reported that weekly initial claims for unemployment were 187,000, which is the lowest level since 1969.
I’d like to leave you with the final line we’ve used since we started these commentaries back at the very height of market volatility in March 2020. Always remember that we create financial/investment plans not for the easy times, but to prepare for the tough ones.