The S&P 500 fell -1.9% last week on the back of continued worries of Federal Reserve monetary tightening actions for 2022. The 10-year Treasury interest rate yield rose to just near 1.75%, up about 25bps since yields troughed in early December (12/3). Higher valuation technology stocks led the NASDAQ lower, falling over -4.1% on the week. Energy and bank stocks were support by higher interest rates.
The financial markets have quickly moved to the Federal Reserve beginning its short-term rate increases at the March meeting, almost a year earlier than where expectation stood at the beginning of the 4th quarter of 2021. Quoting from the December FOMC minutes, “it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated. Some members also noted that it could be appropriate to begin to reduce the Fed’s balance sheet relatively soon.”
Our sense is that the Omicron variant is causing some early 1st quarter economic weakness in the economy, and as such Fed timelines such as these might prove aggressive with the Fed waiting until some of the virus smoke clears. If the pattern of Omicron holds up, the economic impact should be largely behind us by the end of Q1.
We continue to expect a marked uptick in realized volatility for the first half of 2022. History has shown changes in the balance sheet trajectory (flatter or declining) have coincided with at a minimum stalled stock prices. Periods from 2011-12, 2015-16, and 2018 were all periods with corrective or sloppy and choppy trading when the Fed was slowing of reducing its balance sheet followed by a resumption of the bull market as the economy moved forward, company revenue and earnings prevailed, and investor worries were proven incorrect.
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