Hello, this is Tom Jalics, Chief Market Strategist at Fifth Third Bank
Financial markets had a shaky start to 2022 with wholesale declines in the major U.S. indices. Major U.S. benchmarks all slid as bond yields backed up following more hawkish commentary from the December Federal Open Market Committee meeting minutes. The S&P 500 index fell 1.8%, the Nasdaq fell 4.5% and the Dow Jones Industrial Average finished the week down 0.3%. The U.S. 10-year Treasury yield surged to 1.77%, up 0.26% for the week, hitting its highest level since April 2021. Gold was down 1.8%, ending the week at $1,796/oz. West Texas Intermediate Crude Oil rose 5.0% to end the week at $78.97/barrel.
Last week’s rise in interest rates was largely driven by the ongoing shift in the perception of the Federal Reserve’s reaction function to the pandemic. December’s FOMC meeting minutes highlighted a more hawkish discussion around reducing the size of the Fed’s balance sheet, and at a faster pace, as well as potentially raising short-term interest rates sooner and/or at a faster pace than previously expected. Following the FOMC minutes release, investors are now expecting an 80%+ probability of a short-term interest rate increase as early the March meeting. Additionally, market participants are now expecting three, 25 basis point short-term interest rate increases by year-end. Higher interest rates exacerbated longstanding valuation concerns in growth, tech, and long duration equity shares, as shares of companies in these areas meaningfully declined during the week.
The view from Fifth Third’s Investment Strategy team is that the Fed is beginning to unwind some of the emergency measures put in place during the COVID-19 lockdown of 2020, but monetary policy today remains supportive of economic growth. Importantly, we do not believe removal of emergency measures put on during the depths of the pandemic is a threat to economic growth or stock markets. We have history of tapering and tightening from several years ago which ultimately led to lower bond yields and higher stock prices. In the intermediate term, we expect yields to grind higher as economic growth and inflation are likely to continue. We expect global equity returns to climb the Wall of Worry and be positive in 2022. However, given the tremendous global equity recovery over the past 18 months and lofty current valuations, prospective expected equity returns are likely to moderate and revert to longer-term historical averages in the mid-single digit range. We continue to expect two 25 basis point rate hikes from the Federal Reserve in 2022.
In the week ahead, investors will shift their focus from the Federal Reserve minutes to several relevant U.S. economic figures, including consumer and producer inflation measures, which may add additional pressure on policy makers to act. Throughout the week, several regional Federal Reserve Presidents will speak at events to discuss the economy, monetary policy, and other current events. U.S. confirmation hearings will take place in the Senate Banking Committee as Jerome Powell will serve another term as chairman and Lael Brainard will serve as deputy chair. Finally, fourth quarter 2021 earnings season begins with reports from JPMorgan, Delta, BlackRock, and others.
As always, we will be watching and reporting to you next week. Thank you.
