U.S. and International Equities Lower
The major market indexes finished the month in the red as sticky inflation conditions weighed on last month’s market returns as the Federal Reserve (Fed) increased interest rates by 0.75%. This is the most that the Fed has increased rates at one time in over 25 years. Investors remain concerned about inflation’s potential impact to the economy, the anticipated aggressive path of upcoming Fed rate hikes, slowing corporate profit growth, and pockets of still elevated stock valuations.
In addition, second quarter earnings reports will start to roll in the middle of July. These much-anticipated reports will provide additional guidance on the impact of slower growth and inflation on corporate profits. Some market participants believe that the full impact of inflation has not been reflected in earnings estimates for the second half.
Both oil and natural gas finished June lower, as energy’s dominating run in 2022 could be stalling. The major metals, gold, silver, and copper lost ground for the third straight month even amid inflationary conditions. Falling prices of wheat along with other soft commodities during the past quarter have spurred hope that perhaps inflation might be peaking.
Fixed Income Continues Lower
The Bloomberg Aggregate Bond Index finished lower, reversing course from May. High-yield corporate bonds, as tracked by the Bloomberg High Yield index, finished solidly lower as investors are anticipating weaker economic conditions may potentially cause an increase in defaults. High-yield bonds (Bloomberg High Yield Index), which were a bright spot in the fixed income space during 2021, have been negatively impacted by expected higher interest rates, potential recessionary conditions, and their sensitively to equity market declines. LPL Research’s base case is still that credit conditions will remain generally benign. Both developed international bonds (Citigroup World Government Bond Index) and emerging market debt (JP Morgan Emerging Markets Global Bond Index) lost ground in June.
U.S. Economic Data Recap
Inflation: Headline inflation in May rose 8.6% from a year ago, a slight acceleration from April and the highest year-over-year increase since December 1981. The spike in consumer prices was fairly broad-based but especially noticeable in gas and groceries. Dairy prices rose almost 3% month-over-month, the largest monthly increase since July 2007. That being said, we do see some cooling in durable goods prices. The core CPI (excluding food and energy) fell to 6.0% from a year ago, reaching a four-month low. The Fed’s preferred inflation measure, the core personal consumption expenditures (PCE) Index, fell to 4.7% in May from 4.9% the prior month on a year over year basis.
May’s producer price index, rose less than 1% for the month and over 10% over the past year. The monthly rise was in line with Bloomberg forecasts and a doubling of the 0.4% pace in April. Excluding food and energy, core PPI rose 0.5% for May. This came in slightly below economists’ expectations, but it still represents an increase from the 0.4% reading in the previous month. On a year-over-year basis, the core measure was up 8.3%, slightly below expectations and April’s 8.6% increase.
U.S. consumer: U.S. consumer confidence declined last month as sticky inflation left consumers worried that economic growth could worsen during the second half of 2022. The expectations index, based on consumers’ short-term outlook for income, business, and labor market conditions, dropped to its lowest level since March 2013.
Retail sales: May retail and food spending posted a decline of 0.3% month over month, which was below economists’ expectations. Retail sales were well-below the pace in April. They posted a downwardly revised 0.7% increase from the initial 0.9% estimate. On a yearly basis, May retail sales increased over 8% as spending, combined with higher prices, has put a floor under the sales numbers. The negative effects of inflation on the pocketbooks of consumers does appear to be affecting spending. This mirrors negative earnings guidance provided by some major retailers.
U.S. home sales: Pending home sales increased slightly in May compared with April, according to the National Association of Realtors. That being said, pending sales were over 10% lower compared to May 2021. An increase in housing supply, along with a slight pullback in rates, was credited for this increase compared to April this year.
Existing-home sales declined for the fourth consecutive month in May, according to the National Association of Realtors. Total housing inventory at the end of May was over 1.1 million units. This reading represents an increase of over 12% from the previous month as well as a decline of over 4% from May 2021.
Small business sentiment: The National Federation of Independent Business (NFIB) May Small Business Index continued to show that many of the same challenges that have affected small businesses for over a year have not dissipated. Inflation and labor shortages continue to weigh heavily on short-term expectations. Over 50% of small business owners are reporting job openings that cannot be filled. Over half of businesses across the country are increasing capital expenditures which is a potentially positive sign for economic growth later this year.
Federal Reserve news: The Fed announced in June that it was raising its benchmark rate by 0.75% to a range of 1.5 – 1.75%. This was the first 0.75% move since November 1994. The possibility of a 0.75% hike seemed far-fetched a week before, however an upside surprise in the latest reading of Consumer Price Index (CPI) index inflation changed the Fed’s thinking as short-term yields soared and market-implied rate hike expectations climbed higher. New projections saw the median expectation for 2022 growth pulled down to 1.7%, compared to 2.8% in March, and the year-end policy rate expectation increased to 3.4%, up from 1.9% in March. Our base case is that these projections don’t fit together well unless the Fed gets a very friendly economic environment. In order for this to happen, supply chains need to improve with more workers entering the job market.
U.S. employment: June employment increased by just under 400,000, a slightly lower clip from May. The participation rate dipped to 62.2% in June from 62.3% in May. The labor market remains extremely tight as the unemployment rate remains stubbornly low at 3.6%. This rate has remained unchanged for the fourth consecutive month.
Given the present significant inflation challenges, along with the Fed’s response to price pressures, many market participants are anticipating that an economic contraction could be in the cards. We believe that this is unlikely, at least for 2022. Moreover, our base case is that improvement of COVID-19 conditions in China could help improve the global supply chain landscape and thus help ease supply-side driven inflation.
Market participants are presently weighing the effects of all these factors, with this uncertainty leading to higher volatility in financial assets. Our base case remains that inflation should begin to stabilize once supply chains move back towards their pre-COVID-19 operational capacities. How inflation will be managed by the Fed and the effects of tighter monetary policy on the economy will remain the major themes for the rest of this year.
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