Markets ended the week lower as soaring energy prices stemming from the current Middle East fighting continued to place downward pressure on broader financial markets. Despite three weeks of fighting, neither side appears ready for a détente, as both continue to threaten further attacks against key infrastructure sites including energy facilities, power plants, and desalination plants. Additional attacks raise the specter of sustained higher energy prices long after the actual fighting stops. On Wednesday, Qatar, the world’s third largest exporter of liquified natural gas (LNG), announced that an attack on a key LNG facility will reduce its export capacity by ~17% for the next 3-5 years until repairs are completed.
In response to concerns about elevated energy prices and their inflationary impacts, bond yields rose, pushing the 10-Year Treasury yield to an eight-month high. After entering the year pricing in an ~75% chance of at least two Fed rate cuts, markets now expect just a 7% chance of one cut. More notably, markets are now pricing in a nearly 30% chance of a rate hike by year end.
The reduced expectations for a rate cut, coupled with higher energy prices, and broader concerns about higher inflation and its potential to impact economic growth, weighed on small caps which ended the week in correction territory, down 10.3% from their recent high in late January
As expected, the Federal Reserve voted to leave rates unchanged following its Federal Open Market Committee (FOMC) meeting. Speaking at his post-meeting press conference, Fed Chair, Fed Chair Jay Powell noted the economy has been expanding at a “solid pace.” Addressing the current Middle East fighting, Powell said in the near term “higher energy prices will push up overall inflation, but it is too soon to know the scope and duration of the potential effects on the economy.”
