Russia attacks Ukraine. On February 21st Russia officially recognized two self-proclaimed states in the Donbas. A few days later, a full-scale attack on the country of Ukraine. The world watches the Putin-led aggression on a live feed, as the reports are continuous and the global macro picture has been altered for 2022.
While most of our notes are focused on market color, the Piton team is empathetic to the human impact these troubles may cause as well as potential broader implications. We pray for the safety of the Ukrainian people and hope for a peaceful and swift resolution.
Equity market volatility spiked in February. There were extreme intra-day swings, along with risk-off days and rebounds based on the latest reports. January’s bear market levels were breached during February as broad equity markets fell, leaving the major US indices down over 3% for February (and the S&P 500 Index -8.02% year-to-date). Much like January, all stock sub-sectors were lower except energy, as oil prices soared to $100+ a barrel level.
US bond market prices continued to fall in the first half of the month as higher rates, and now, significant credit spread widening hampered performance. US investment-grade bond markets experienced the worst two months since the global financial crisis. It is also the weakest bond market start to a year since 1980. These scenarios sharply reversed as March began.
- While the benchmark US Treasury 10-year note breached 2% for a few days in mid-February, it ended the month at 1.83%, just 5 basis points higher than the end of January.
- The US government sector performed better than riskier bonds, broad corporate bonds were down 2% for February, after falling 3.37% in January.
- Municipal bond performance has also fallen over 3% year-to-date in 2022.
Markets underwent a textbook risk-off atmosphere as the war on Ukraine entered a more violent phase. Interest rates fell, risk premium spreads widened and equities weakened further while commodities, including gold and oil, moved higher.
The most jarring headline for markets came as Putin placed his army on high alert with nuclear weapons. Broad sanctions initially helped financial markets. SWIFT financial system sanctions also created market fear as some European bonds and coupons utilize that system for payment. As Russian markets and the Ruble crumbled investors shunned Russian exposure including some European banks and consumer industries with large Russian exposures.
While the Russian attack was the major catalyst for markets, volatility was in the cards after a dismal January. Diverging central banks' comments had markets on edge. Equities rebounded early in February on solid earnings but misses from big companies like Facebook had participants questioning the popular “metaverse” theme.
On February 3rd, the Bank of England raised their key interest rate to 0.50% from 0.25% and began unwinding quantitative easing. Certain officials voted for bigger rate hikes, fueling the idea of bigger hikes in the US. The European Central Bank stated they were closer to raising rates, yet Chairwoman Lagarde stated that she expected inflation to fall to target inflation over time.
Much of the Economic data before the week of February 21st, increased the potential for larger Federal Funds rate moves by the FOMC. On February 4th, non-farm payrolls were much stronger than expected (467k versus expectations of 125k) and average hourly earnings increased. On February 16th, retail sales data showed a big jump in sales (3.8% month-over-month versus expectations of 2%). Existing home sales were also strong.
In addition, inflation data remained elevated. Headline and core CPI data confirmed broad inflation pressures. PPI also beat expectations for the month. As the attack on Ukraine ensued, oil prices continued to rise, increasing inflationary stress.
On February 16th the FOMC meeting minutes confirmed rate hikes were to start in March. Balance sheet reductions were not specifically addressed, but many thought Fed would wind down bond purchases quicker. It was clear many Fed governors favored larger increases in March, as the Fed was facing a “behind the curve” stigma on inflation. As Russia moved closer to attacking Ukraine, and Treasuries rallied, consensus priced out larger rate increases and put the Fed in “a very difficult position”.
As we enter March, new market perspectives have plowed into the macro picture. Will the war, and energy price shock, slow growth globally? Europe could face a recession as they no longer engage in trade with Russia. Will central banks need to refocus on growth concerns rather than inflation pressures? As Ukraine has shown fight, even as their capital is surrounded, what will Putin’s end game look like? How quickly will sanctions work?
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