It’s a melting point of tension and concern in the markets, from geopolitical risks to looming interest rate increases as equities fluctuate more on investor sentiment and less on fundamentals. Strategists on Wall Street anticipate economic and earnings impacts from rising oil prices, interest rate increases, lingering and broadening inflation, as well as the potential for a war between Russia and Ukraine, writes Mark Hackett, chief of investment research at Nationwide, in a recent blog.
Earnings season this quarter has been the weakest one experienced since 2014, and while it’s not quite over yet, the ratio of companies above compared to below consensus guidance remains weak. Corporate sentiment is down too, at its lowest since mid-2020 when the onset of the COVID-19 pandemic caused economic shutdowns across the globe.
The S&P 500 fell 2% on Friday and closed at a year-to-date loss of 7%, and bond markets had a 0.22% surge in the 2-year Treasury yield last Thursday while the 10-year Treasury yield crossed 2% for the first time in three years. The gain of the 2-year Treasury was the single largest standard deviation move seen since 1979.
“Two prominent economists from opposite sides of the political spectrum, former Fed Governor Lawrence Lindsey and ex-Treasury Secretary Lawrence Summers, warned that the odds of a recession in the near term are over 50%,” Hackett writes.
A rapidly flattening yield curve driven by concerns of Fed policy missteps has created the lowest level spread between the 2-year and 10-year Treasury since the beginning of the pandemic. St. Louis Fed President Bullard made remarks regarding a need for aggressive rate hikes, culminating in a 1% increase by July that led to the Fed Futures curve peaking at 93% odds for a 0.50% interest rate increase in March before falling back to 66% on Monday.
Within the span of two months, anticipations for interest rate increases have grown from three or four in December’s “dot plot” to the Fed Futures curve now anticipating seven or more rate increases this year. This comes at a time when the CPI shows inflation that is not only continuing to run hot but also becoming increasingly broad as it spreads from the more cyclical categories it was once contained in.
“Right now, investors are selling first and asking questions later. But reacting to overreaction is rarely a sound strategy. While risks created by Russia, Ukraine and China are top of mind for investors, history has shown that these types of geopolitical tensions end up being more worrisome than impactful,” Hackett writes regarding the rapid escalation between Russia and Ukraine.
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