Financial markets are being driven by developments in Ukraine: The more there are prospects of a peaceful solution the more markets re-focus on fundamentals, which means global inflation (exacerbated by conflict in Europe and therefore supply shortages) and, in the US particularly, a very strong labour market.
Treasuries posted their worst quarter since at least 1973 after the Fed raised interest rates for the first time since 2018 in March in its attempt to battle inflation, which is running at its highest level in 40 years. It has also halted its crisis-era bond-buying programme.
Indeed, the 10-year US Treasury moved from a 1.75% Yield-to-Maturity a month ago when the Russia/Ukraine conflict was at its very worst to reach 2.50% YTM ten days ago as the market looks at a possible peaceful solution and bonds loose ther ‘safe haven’status. Remember – bond yields up – bond prices down i.e., losses for bond investors.
Another striking feature of the US Government Bond market is the inversion of the yield curve i.e. shorter maturity bonds now yielding more than longer dated bonds. We normally look at the yield difference between the 2- and 10-year Treasury yields to assess this.
The yield on the two-year note finished the quarter at 2.44% YTM and the 10-year bond finished the quarter at 2.38% YTM. This is the first time the 2-year yield has climbed above the 10-year since August 2019.
Such inversions of the yield curve have typically been perceived as a sign that the economy is at risk of recession i.e., investors are not predicting high interest rates (to combat high inflation or a strong economy) looking at a 10-year time horizon. Perhaps this is an indication of a US recession in 2023 or 2024?
Two reasons why short-term / 2-year yields have risen so much this year is
- Strong inflation – The annual inflation rate in the US is 7.9% in February, the highest since January of 1982 and well above the Fed’s 2% target!
- Strong employment data – the latest batch of labour market data showed the US recorded another month of strong job creation – 431,000 jobs last month on top of 750,000 the previous month
Accordingly, the Federal Reserve increased the key ‘Fed Funds rate’ by 0.25% at their March FOMC meeting and market expectations are for a further seven or so rate increases, possibly at each of their remaining 6-weekly meetings, for the remainder of the year. Indeed, some 0.50% / 50 basis point rate rises are expected which is unusual.
Although global equities have rebounded in price as Russia /Ukraine peace talks take place, US stocks end the quarter with their worst performance in two years.
The benchmark S&P 500 index fell 4.9 per cent over the three months to the end of March, while the tech-heavy Nasdaq Composite declined 9.1 per cent. It was the weakest quarter for both, and also the first quarter of losses for the S&P 500, since the first quarter of 2020.
There are a lot of good reasons for a down quarter. No matter which way you turn, there is more uncertainty. Which way will the war in Ukraine turn? How will the Fed conduct policy?
Oil prices weakened last week after the US announced a “historic release” of about 180mn barrels from its Strategic Petroleum Reserve in response to a global supply shortage.
The Opec+ group of oil-producing nations said it would aim to raise production by 432,000 barrels a day in May, continuing with the monthly plan agreed last year to gradually replace output cut at the start of the pandemic. Brent crude, the international oil benchmark, finished the quarter at $108 dollars per barrel, down from the conflict high of $139 p.b. but nonetheless oil prices have risen almost 40 per cent in 2022.
NEW BOND/EQUITY ISSUANCE
Global fundraising in capital markets shrivelled by more than $900bn in the first quarter from the same period in 2021 as surging inflation, war in Ukraine and volatile asset prices delayed stock listings and hampered bond deals. Businesses raised $2.3tn in the first three months of the year through equity sales and new borrowings in bond and loan markets, the smallest sum in six years and down from more than $3.2tn from a year ago. This obviously means significantly less fee income for Investment Banks.
SUMMARY Clearly a huge feature of the first quarter of this year has been price volatility across all asset classes. As uncertainty across many topics remains, it is likely that the second quarter of the year will follow a similar pattern.