Second Quarter 2022: Nowhere to Run – Nowhere to Hide
Major U.S. and global equity indices have shed almost a fifth of their value in the first half of 2022, the third-worst start to the year in the last century for U.S. stocks. Bonds, which have typically acted as a ballast in past selloffs, are off to their worst start to the year on record, with investment-grade debt down 11% over the first six months, as measured by the Bloomberg Aggregate.
Those looking for a culprit for the significant selloff in both stocks and bonds do not need to look much further than inflation. Inflation, which is running at its highest level in 40 years, has been much less “transitory” than forecasted. Pent-up demand from the pandemic fueled by record monetary & fiscal stimulus collided with supply-chain issues, and a surge in domestic energy prices that has now been sustained by Russia’s invasion of Ukraine. Resolution of the supply side of the mismatch depends on the return of normal supply chains, with semi-conductor and oil production of particular importance.
Absent the ability to fix the supply side of the equation, inflation’s persistence has forced a hawkish shift from the Federal Reserve to constrain demand. The FOMC is now projecting raising the federal funds rate above 3.4% in 2022, a far cry from the singular 0.25% hike the FOMC had foreseen as necessary to curtail inflation in their September 2021 projection materials. The swift shift in policy tightening has directly impacted the real estate market as mortgage rates have nearly doubled from 3% to almost 6% over the last year. Federal Reserve Chairman Jerome Powell noted that homebuyers “need a bit of reset” until supply can catch up to demand.
The big question in the second half of the year is if the central bank can engineer a “soft landing” for the U.S. economy where inflation comes down without provoking a recession. Powell himself has said there are no guarantees, but he remains upbeat given the relative health of businesses and the strength of the labor market.