June 2022 Market Commentary
July 8, 2022
Growing recession concerns fueled by the Fed’s increasingly aggressive stance towards monetary policy resulted in the S&P 500’s second-worst month since March 2020, capping the index’s worst first half of a year since 1970. Following a brief reprieve in May, inflation data reported in June reaccelerated, as strong demand, fighting in Ukraine, and Chinese Covid lockdowns continued to pressure prices higher. In response, the Fed conducted its largest rate increase in over 25 years while affirming its commitment to tackling inflation. However, given the Fed’s poor track record of raising rates without causing a recession, investors are understandably nervous. Curiously, the current debate around the possibility of recession seems to overlook the fact that economic growth was all but certain to moderate in 2022, following the unsustainable 5.7% GDP growth recorded in 2021. What is different now, however, compared to the outset of the year, is that now Fed policy is viewed as a hindrance to economic growth, whereas at the outset of the year, it was viewed as supportive of economic growth.
Recessions can be caused by numerous factors. More recent US recessions have resulted from the collapse of the “Tech Bubble” and economic disruptions stemming from the 9/11 attacks (2001), the collapse of the housing market (2007-2009), and the global Covid pandemic (2020). Some economists posit that recessions can effectively be self-fulfilling. That is, the more that economists, corporate leaders, and individual consumers talk about the possibility of a recession, the more likely it becomes. While “self-fulfilling prophecy” has never been cited as the official cause of a recession, concerns of a recession can lead companies to cut back on investment and hiring, and consumers to cut back on spending, thereby creating a negative feedback loop that ultimately results in recession.
Contributing to self-fulfilling prophecies is confirmation bias, which, according to Encyclopedia Britannica, is, “the tendency to process information by looking for, or interpreting, information that is consistent with one’s existing beliefs.” Or, as Warren Buffet succinctly stated, “What the human being is best at doing is interpreting all new information so that their prior conclusions remain intact.” In June, given the generally downbeat mood of investors, that meant interpreting any slowing data as “confirmation” of a pending recession, while discounting any improving data as an anomaly that will soon reverse. That pessimistic view contributed to monthly losses across the board. US large caps (S&P 500) and small caps (Russell 2000) both fell 8.4%, while international developed (MSCI EAFE) and emerging markets (MSCI EM) fell 9.4% and 7.1%, respectively.
Economic data released during June painted a mixed picture of the US economy. Though many indicators did slow, they were not necessarily suggestive of an economy teetering on the brink of recession. Employment, often viewed as a lagging indicator of economic health, remained a relatively bright spot, with the economy adding another 390K new jobs in May. Weekly jobless claims, considered more of a leading indicator of economic health, ticked up to 232K, the highest monthly average in eight months suggesting some cooling of the labor market. However, overall labor conditions remain tight as evidenced by job openings, which at 11.3M, equate to ~1.9 jobs available for each unemployed individual, close to historic highs. Moving forward, employment data is likely to show signs of slowing, part of the resulting “pain” the Fed expects from its efforts to curb inflation.
Consumer data released in June was mixed as consumers continued to grapple with higher prices. Total consumer spending slowed to 0.2% in May but actually fell 0.4% on an inflation-adjusted basis. Spending on goods declined 0.7%, while spending on services increased 0.7%, as consumers increasingly resumed pre-Covid activities such as eating out and traveling. Highlighting that latter was a 19% increase in TSA checkpoint traffic at airport security, compared to June 2021. Another notable consumer trend over the past several months has been a surge in credit. While it’s unclear exactly what’s driving it, it could be a sign that negative real wage growth due to higher inflation is forcing consumers to turn to credit cards to fund spending. The surge in credit has come as the savings rate has fallen to its lowest level since 2009, suggesting a consumer that is feeling squeezed by higher prices.
Housing has perhaps been the sector most visibly impacted thus far by the Fed’s rate hikes. After starting the year at 3.1%, the average 30-year mortgage rate now stands at 5.7%. On a $1M home financed with a traditional 30- year mortgage, at a loan-to-value of 80% (i.e., 20% down payment), the jump in rates increases the monthly mortgage payment by $1,200, a not-insignificant amount of money for many families. The rise in rates has led to a dramatic slowing in mortgage applications along with sales of both new and existing homes.
For fixed-income markets, June was a tale of two halves. The first half saw 2- and 10-Year Treasury yields reach decade highs on stronger-than-expected CPI inflation data. The data release came at an inopportune time, as the Fed had already entered its quiet period ahead of its June Federal Open Market Committee (FOMC) meeting. This left an informational vacuum in which speculation that the Fed would act more aggressively than previously anticipated grew, leading to a bond market sell-off. Yields peaked the day before the Fed’s decision to raise the Fed Funds rate by 75 basis points (0.75%). Speaking after the meeting, Fed Chair Jay Powell reasserted the Fed’s pledge to aggressively tackle inflation in order to bring it in-line with the Fed’s longer-term target of 2%. The combination of the unusually large hike (the largest since 1994) and continued hawkish rhetoric satiated calls for the Fed to respond more forcefully to the highest inflation in 40 years.
The second half of the month saw investors grow increasingly concerned about the Fed’s ability to raise rates high enough to quell inflation, without triggering a recession. Such a feat, known as a “soft landing”, has historically proved elusive for the Fed and may well again, with Fed Chair Powell indicating that effecting such an outcome will be “very challenging.” Investor angst was further compounded by slowing economic data despite the Fed being only about halfway through their expected hiking cycle. Those growing recessionary fears helped pull yields back down, about 45-50bps from their highs, across the curve, by month-end.
In addition to the up-and-down moves in yields, the broader Treasury curve flattened considerably in June, reflecting the difficulty that the market sees in the Fed’s ability to engineer a soft landing. Despite the recessionary fears, yields rose in June, with the 2-Year gaining 0.39%, and that 10-Year gaining 0.17%, in response to higher inflation and the Fed’s corresponding 0.75% rate hike. Higher rates resulted in the Bloomberg Aggregate Bond index falling 1.6% for the month. The municipal markets saw a similar, though more muted pattern. Yields on the 2yr AAA muni rose just 7bps on the month, while the 10yr saw a 25bps jump. For the month, munis fell 1.9%.