June capped off a historically negative quarter in financial markets, as the Federal Reserve lifted the Federal Funds rate to 1.75%; up 75 basis points. Equity markets continued to falter and rates spiked and then fell as recession risk became the primary catalyst for global markets.
Equity markets were trampled in June, finishing a dismal first half of 2022. The S&P 500 Index fell by 8.26%, the DJIA fell by 6.56%, and the Nasdaq fell by 8.65% in June alone. While the FOMC’s higher rate action certainly has stocks on the defensive, the rising potential for a “hard landing” in the US is creating fear in equity and credit risk.
In “textbook” recession fashion, the sectors most hurt last month were consumer discretionary (-10.9%), financials (-11.07%), materials (-14.08%), and energy (-16.98%). Historically defensive companies performed best; healthcare (-2.84%), Staples (-2.87%), and utilities (-5.13%).
Government yields rose in June right up to the day before the Fed announcement. The U.S. 10-Year Bond yielded 2.85% at the beginning of June, touched 3.5% on June 14th, and fell back to 3.02% by month-end. In all, Treasuries finished with negative performance, but not in a parallel manner. Month-to-date, shorter yields rose much more than longer maturities, in a “bear-flattening” trend. 1-Year T-bills rose 70 basis points on the month to yield 2.78%, and 2-Year Treasury Notes rose by 40 basis points to yield 2.96% on June 30th. 10-to-30-year bonds rose by 15 basis points on average.
Other sectors in fixed income fared worse as inflation and recession predictions served as headwinds. Corporate bond prices fell much more than Treasuries as risk premium spreads widened (Bloomberg Corporate Bond Index -2.80%, versus Treasuries -0.88%). Municipal bonds underperformed, falling 1.64% in June. High beta sectors in bonds, had their worst month since the start of Covid as weak equity markets widened their spreads to corresponding government bonds. Total return in high yield bonds fell by -6.73%, and emerging market bonds fell by almost -5% (over -18% year-to-date).
June Market Drivers
- FOMC June 15th 75 Basis Point Rate Increase and Fed Commentary: While the first 75 basis point Fed hike since 1994 was widely expected, some of Chairman Powell’s comments changed the dynamic of the message. The announcement included comments that the Fed was “strongly committed to returning inflation to 2%”, and the average expectation for the Fed Funds rate at year-end 2022 would be approximately 3.4%, and 3.8% by the end of 2023. Powell mentioned that he did not see 75 basis point hikes as a regular occurrence, which gave some support to bond prices that were bracing for more hawkish language. Investors reversed thoughts the following day as the thought of 4% short-term rates drove bond and equity prices lower. Future comments of a more “front-loaded Fed” pushed front-end rates higher. Longer bonds rebounded as the prospect of Fed Tightening and Quantitative Tightening would eventually “break something” in the economy, potentially causing a “hard-landing” recession.
- Inflation: Last month’s inflation reading continued to support an aggressive Fed and cautious consumer. Everyone is seeing anecdotal evidence from airlines to gas prices, and June’s readings remained elevated with only very small signs of moderating by month-end. Manufacturing prices remained high in the ISM Prices Paid report for May, and first quarter unit labor costs topped 12.6%. Employment data showed that wages remain high. PPI and CPI reports continued at alarming levels, as the owner’s equivalent rent (OER) portion of CPI suggests higher yields are forcing demand in renting versus buying real estate. There were more obvious signs that Fed rate targeting has started to bite in some of the more flexible inflationary sectors, such as used autos.
- Economy: June was a pivotal month for the assessment of a pending recession. Even the Fed commented on the challenging task to engineer a soft landing of the US economy in the face of an inflationary environment. Companies continued to “guide down” expectations from margin pressures. Monthly retail sales numbers were shy of expectations. There were some clear signs of slowing in housing as the monthly housing starts data and existing home sales data fell in May. Consumer sentiment has also fallen off in the monthly economic surveys. In contrast, there are some very important economic tailwinds, that continue to support a robust US economy. Employment is still very strong, nonfarm payrolls increased by 390,000 in May, above estimates. In addition, China is just “re-opening” from covid closures, suggesting our biggest trade partner will re-emerge.
- Intangible Factors: June was filled with volatile trading days and large market reversals in the blink of an eye. Most were some derivations of the factors above, while Bitcoin and the crypto markets were quite newsworthy in June as well. Certainly, some of the run for cover in government bonds was a result of one of the worst months and quarters for crypto. Bitcoin is now 72% off its high price, down 58.5% in the second quarter, and down 41% in June alone ($18,731). Many Crypto related companies announced layoffs and cutbacks, and many predict consolidation and insolvencies in the sector.
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