Laura Mccabe

The Commerce Department reported that the U.S. economy contracted by 1.4% in the first quarter, way below expectations. A record trade deficit was mainly to blame as consumer spending remained strong. Other economic data such as capital goods orders and personal spending showed continued expansion. The 10-year U.S. Treasury yield ended the week unchanged at 2.94%, but there was underlying volatility as the yield reached the low of 2.72% earlier in the week before rising.

Equities fell again last week for the third consecutive week. The fear of a more aggressive Federal Reserve raising rates to tame inflation caused investors to sell. Hawkish comments from Fed chair Powell on Thursday caused rates to go higher, causing the selloff in the equity markets to accelerate towards the end of the week. Technology and communication services sectors lagged as value performed better than growth. On the strength of the U.S. economy, we received mixed data. The Purchasing manager’s index (PMI) showed expansion, but the services PMI dropped from the previous month but also showed expansion. The 10-year Treasury rose to a three-year high at just under 3%.

With U.S. inflation at a forty-year high, the Federal Reserve is pressured to be aggressive in reducing monetary accommodation by raising rates. The robust U.S. labor market, reflective of a strong economy, gives the Fed the ability to be aggressive in raising rates. Initial jobless claims two weeks ago came in at the lowest level since the late 1960s. Last week, initial claims did rise some, but it remains near a half-century low. The labor market’s strength considering the economic consequences of Russia’s war against Ukraine and companies facing multi-decade high producers price index is striking. The likelihood that the Fed will raise interest rates in early May by 50bps is high.

This week, earnings season picks up with some of the largest financial firms reporting, such as Goldman Sachs, Wells Fargo, BlackRock, Citigroup, and JPMorgan Chase. On the economic front, the Consumer Price Index (CPI) and Producer Price Index (PPI) will be released on Tuesday and Wednesday, which all investors will be paying close attention to. CPI is expected to increase from the previous month as costs of goods and services continue to rise. Retail sales data and the University of Michigan’s preliminary reading of its Consumer sentiment Index for April will be released on Thursday. The preliminary reading of the Consumer sentiment index will provide insight into inflation’s effect on consumers. Consumer sentiment has been at a multi-year low. Retail sales have held strong over recent months despite rising prices.

The Bureau of Labor Statistics report showed strong jobs growth in March as higher wages encouraged workers back to the labor force. Noticeable job gains were in the leisure and hospitality sectors, which was encouraging. For the first quarter of 2022, job growth averaged north of half a million per month, according to FT.com. The unemployment rate dropped to 3.6%, the lowest level since before the pandemic. The lower unemployment gives the Federal Reserve another data point supporting a more aggressive monetary policy to tame inflation. Strong labor data caused a further sell-off in short-dated U.S. government debt, causing further flattening of the yield curve.

The U.S. labor market continues to see improvement as jobless claims fall. The Bureau of Labor Statistics will release February Job Openings and Labor Survey (JOLTS) on Tuesday. It shows the number of job openings for the month. The Fed’s preferred gauge for inflation, the PCE Price Index, will be released for February on Wednesday. It is likely to show costs of consumer goods and services continued to rise as commodity prices and raw materials have soared following the invasion of Ukraine by Russia.

Federal Reserve Chair Jerome Powell gave investors something to cheer about when he said that his first interest rate in four years wouldn’t throw the economy off its course. The Federal Reserve raised rates by a quarter-point on Wednesday as anticipated. The Fed Chair touted the strength of the U.S. economy and stated that the probability of a recession in the next year was not “particularly elevated.” Strong employment, rising wages, robust consumer spending, and healthy household balance sheets support a strong U.S. economy. The economic situation in Europe may be different. The energy shock of the Ukraine war has had a much bigger impact on Europe because Europe relied on natural gas from Russia.

A surge in commodity prices after the Russian invasion of Ukraine combined with multi-year high inflation has many worried about the risk of stagflation. Stagflation happens when the economy is experiencing either stalling or falling output while experiencing high inflation. The last time this happened in the U.S. was in the 1970s, when the creation of OPEC sent energy prices soaring. Consumer confidence in the U.S. is already at a multi-year low and could get worse given rising prices. The Federal Reserve is in a tough situation because it needs to tame inflation by raising rates but at the same time does not want to weaken the economy further. The Russian invasion of Ukraine has raised the risk of recession as economic growth estimates have been revised down.

With oil prices above $110 per barrel, inflationary pressures will continue to drive prices higher. There are two scenarios on how this could play out. The optimistic scenario is the announcement of a ceasefire, and energy prices stabilize around current levels. Expect a small hit on economic growth and the Fed will continue its plans to tighten monetary policy. In the grimmer scenario, the conflict continues, and more sanctions are imposed on Russia. Here, energy prices go higher, inflation is soaring, and the possibility of oil supply chain disruptions push longer-term inflation expectations higher.

With the overnight invasion, International Developed and Emerging Markets ended the week down -2.5% and -4.9%, respectively, while the S&P 500 gained 0.84%. In addition, the best performing S&P 500 sectors for the week were Healthcare, Utilities, and Real Estate further validating a flight-to-safety environment. Though U.S. equity markets rallied that last two days, Sowell’s tactical signal was tipped into negative cautious territory as the underlying fundamental factors exhibit short-term macro uncertainties when it comes to interest rates, bond spreads, and inflation.