Summer bounce. Both equity and fixed income markets had strong rebounds in July as the Fed raised rates another 75 basis points but left the future path of rate increases uncertain. Stock markets climbed after a volatile start to July, with the S&P 500 index ending up 9.22% in the month. Bond returns snapped back as yields dropped across the intermediate and longer parts of the US yield curve. The benchmark US treasury 10-year note fell approximately 36 basis points to yield 2.65% by month end (down from 3.01% in June).
Risk markets had a very strong month. Credit markets outperformed government bonds as investors seem less worried about the severity of a recessionary period. Municipal bonds, IG corporates, emerging market debt, and high yield bonds all recorded strong positive monthly total returns.
July Market Drivers
The July 27th FOMC decision, the July 28th Q2 GDP release, and earnings announcements throughout the month drove markets in July.
- FOMC July 27th 75 Basis Point Rate Increase: While some fed watchers anticipated a 100-basis point move given stubborn inflation numbers, 75 basis points was the consensus view from economists. The Fed delivered its second 75 basis point hike this year with a unanimous vote and reiterated the committee’s primary goal remains to bring inflation down to the 2% level. The current Federal Fund rate is at 2.25%-2.50% and is expected to move higher at the September meeting and beyond. Despite more liquidity being reversed from the economy by the FOMC, Chairman Powell made comments that eased market fears. He stated the Fed would wait and see all data points before September’s meeting to decide on the level of a rate increase. He also noted some of the weaknesses in the economy, that the economy would likely slow, yet the employment picture remained strong.
- July 28th Q2 GDP Release: Consensus for the initial Q2GDP read was to be slightly positive at +0.4%, but the figure released was -0.9%. Inventory levels were a key driver. With two consecutive quarters of negative GDP, many investors now believe the US has entered a recession. Despite the “technical recession”, some believe the strength of the employment does not add up to what would be considered a recessionary environment. This contested event gave markets a boost, as many believe the Fed will pull back from extraordinarily rate hikes in future months. Many also believe risk markets have already been priced to a mild recession.
- Earnings Season: Earnings added to the recession debate throughout the month as many industries reported solid results yet continued to “guide down” future reports due to inflationary forces affecting the consumer. Most notably, Walmart issued a surprising pre-earnings lower profit outlook. This came just days before the FOMC announcement and sent a message that high inflation has caused consumers to spend less on general merchandise, especially clothing. While some see this as a specific inventory mistake by a few large companies, consumer confidence continues to fall. Despite some of the warnings, valuations and earnings reports drove sectors to strong returns in July. The consumer discretionary sector led the market, up 18.9% followed by the technology sector, up 13.5%. Health care and staples lagged, up just above 3% each. Not exactly what most would expect as the beginning of a recession.
- Economic Data: Economic data for the month showed some obvious signs of slowing, but not in all categories. Housing has fallen rapidly with higher interest rates. New home sales for June were down 8.1% and existing home sales fell by 5.4%. Consumer confidence and small business optimism have fallen, but the service sector remains strong. Retail sales were surprisingly healthy and the non-farm payroll figures for June beat economists’ estimates (+372,000 jobs for June). These figures will be extremely important to financial markets in August and September as they will chart a course for September’s FOMC meeting and determine if a “Fed Pivot” is necessary.
Given the 2022 move in yields and the potential for an economic slowdown, we view fixed income as a protective asset class. While Fed action can still push rates higher, the increased compounding of higher yields will create a more beneficial total return environment for the second half of the year.
The Piton team continues to offer customized portfolios and solutions to meet your needs through all market and interest rate environments. Please let us know how we can help you and your clients; we are here to serve as an extension of your team.