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Rising bond yields and Fed minutes send stocks lower


The whole secret to winning big in the stock market is not to be right all the time, but to lose the least amount possible when you’re wrong. – William J. O’Neil, a noted investor, stockbroker and author 

Hawkish comments by Federal Reserve Governor Lael Brainard and minutes from the Fed’s most recent meeting in March were the primary reason stocks finished lower last week. The Dow Jones Industrial Average suffered only a modest loss while the S&P 500 Index dropped over 1%. The technology-heavy Nasdaq Composite Index was the biggest loser with a decline of nearly 4% as rising interest rates took their toll on those stocks with the highest valuations. While April has been the best performing month for the stock market over the last 20 years with an average gain of 2.41% and has been up in 16 of the last 17 years, it will be a tall order for that trend to continue. High inflation, the war in Ukraine, rising bond yields and Federal Reserve tightening are significant headwinds for the market to overcome. On Tuesday, Lael Brainard said the Fed needs to shrink its balance sheet “rapidly” to reduce high inflation. The next day minutes of the Federal Reserve meeting showed that Fed officials agreed that it should reduce its balance sheet of securities by $95 billion a month. They also indicated that the Fed was considering larger interest rate hikes that its customary 25 basis point (a basis point is one hundredth of one percent) increments. The total number of forecasted rate hikes now stands at seven, more than double the original forecast of just three.  In hindsight, the Federal Reserve was wrong about inflation being “transitory” and now must aggressively play catch-up after falling behind the curve. Bond yields continued to rise last week, but the yield curve, or the difference between the 2-year Treasury yield and the 10-year Treasury yield, was no longer inverted, a worrisome sign that can portend a slowing economy and even a recession. The 10-year Treasury yield rose to 2.70% while the 2-year Treasury yield settled at 2.53%, a difference of only 17 basis points and relatively flat, which still points to slowing economic growth. The Fed’s goal will be to engineer a soft landing by raising interest rates enough to lower inflation but not too much as to substantially slow the economy or tip the economy into a recession.

Last Week

February factory orders fell slightly due mostly to a decline in transportation equipment as well as machinery, computers and electronic products. The ISM non-manufacturing or services sector index in March was better than expected and higher than the reading in February. Weekly jobless claims fell to 166,000, a decline of 5,000 from a week ago and the lowest level since 1968.

The U.S. banned all new investment in Russia and the Senate passed a bill banning all Russian oil and gas imports.

For the week, the Dow Jones Industrial Average fell 0.3% to close at 34,721 while the S&P 500 Index declined 1.3% to close at 4,488. The Nasdaq Composite Index dropped 3.9% to close at 13,711.

This Week

The March producer price index (PPI) is expected to increase 10.5% year-over-year while the consumer price index (CPI) is forecast to be up 8.4% year-over-year as inflation shows no signs of abating. March retail sales are expected to increase modestly and be higher than in February.

Both the U.S. stock and bond markets will be closed on Friday in observance of Good Friday.

This week marks the beginning of first quarter earnings season and banks and other financial companies will dominate the announcements. Among these are JP Morgan Chase, Citigroup, Wells Fargo, U.S. Bancorp, PNC Financial Services, State Street, Goldman Sachs, Morgan Stanley and BlackRock. Other notable companies include UnitedHealth Group, Taiwan Semiconductor Manufacturing and Delta Air Lines.

Portfolio Strategy

While the brutal war in Ukraine will continue to receive attention in this holiday-shortened week, the primary focus for investors will be the March inflation data as well as quarterly earnings for the big banks and financial firms. The consumer price index (CPI) will be released on Tuesday and it is expected to increase above 8%, which could be the catalyst for bond yields to move higher and give the Federal Reserve a reason to raise the federal funds rate in May by 50 basis points. The producer price index (PPI) follows on Wednesday and it’s anticipated that it will show prices rising over 10% on a year-over-year basis, a level not seen in 40 years. The Federal Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) index, is not scheduled to be released until April 29th, but the inflation data this week could set the tone for the bond market and foreshadow what the Fed will do at its next meeting.  The increase in bond yields since the start of the year has been extraordinary as the 10-year Treasury yield eclipsed 2.7% on Friday and could potentially rise to 3% depending on the inflation data this week. But it is possible that inflation may have peaked in March, which could lead to a rally in bonds as most of the bad news has already been priced in (Bond prices and yields move in opposite directions). Although first quarter S&P 500 earnings are expected to increase about 6%, bank earnings are actually forecast to decline despite the increase in interest rates, which normally helps their net interest margins. Banks typically benefit from a steeper yield curve, but the difference now between the 2-year Treasury yield and the 10-year Treasury yield is less than 20 basis points. Higher rates and a steeper yield curve are conducive to bank profit margins, but they can also adversely affect loan growth and hurt the economy.