Markets Give Nod to Higher Rates 

For at least some of the time last week, investor focus shifted away from the crisis in Ukraine to the Federal Reserve’s long-anticipated raising of its key interest rate. The 0.25 percent increase in the federal funds rate, instead of a more aggressive 0.50 percent hike, was seen largely as a nod to the global economic uncertainty stemming from Russia’s invasion of Ukraine.  

After a very brief initial hiccup, equity markets around the world rallied sharply on the news, while oil prices settled lower. Part of the rationale for investor optimism is that markets like clarity, which the Fed provided with its rate hike and the measured statement from the Federal Open Market Committee after its announcement.  

Somewhat overlooked last week was notable news from China. Government officials there signaled that their regulatory crackdown on tech companies could end soon and that overseas stock listings for tech companies would be supported. In reaction, Chinese stocks rose more than 14 percent, and U.S.-listed Chinese stocks rallied, with Alibaba alone climbing 37 percent last Wednesday. With China accounting for about 40 percent of emerging-market indices, it is not surprising that emerging-market stocks outperformed last week, up almost 8 percent.  

Wall Street wrap  

Fed provides more clarity. In addition to the headline 25 basis-point hike in the federal funds rate, the Fed provided more clarity around its plans for the year. It’s projecting six additional rate hikes in 2022 and said it expects to announce the start of a reduction in its holdings of Treasurys and other securities — so-called “quantitative tightening” — perhaps as early as its May meeting. 

Despite the clarity of its intentions, the Fed nonetheless noted the significant uncertainty surrounding the impact of the Russian-Ukraine war on the U.S. economy, inflation and economic activity. We believe the Fed will continue to proceed carefully and err on the side of caution in future moves; last week’s modest rate increase is evidence of that.  

Continuing inflation pressure. U.S. producer prices increased 0.8 percent month over month in February, less than an upwardly revised 1.2 percent rise in January and slightly below market forecasts of a 0.9 percent increase. Prices for goods jumped 2.4 percent, the largest advance since data were first calculated in December 2009, mainly due to a 14.8 percent leap in gasoline costs. Year-on-year, producer inflation was unchanged at 10 percent. We may see inflation data continue to tick up in the short term since February figures do not capture the surge in prices of oil and other commodities following Russia's invasion of Ukraine. 

Better news on the inflation front was that core PPI, which excludes food and energy, increased by just 0.2 percent from February, slowing from an upwardly revised 1 percent jump in January and below market expectations of a 0.6 percent increase. February’s increase in core producer prices was the smallest since last September, causing markets to rally. We have been saying for some time that pandemic-induced inflation is starting to recede, so while food and energy prices will grab headlines, we believe the Fed will pay increasing attention to core numbers as they make policy decisions.   

Moderating consumer spending. Retail sales edged up 0.3 percent month over month in February, slowing sharply from an upwardly revised 4.9 percent rise in January and below market forecasts of a 0.4 percent gain. If we exclude gasoline sales, which rose 5.3 percent on rising gas prices, retail sales fell 0.2 percent. Some good news: Spending is continuing to shift to services. Notably, the report showed that spending in restaurants and bars increased 2.5 percent, a sign that consumers are venturing out as the economy continues to return to its pre-COVID normal.  

A brighter future? The Conference Board’s Leading Economic Index (LEI) for February posted a 0.3 percent gain over January’s 119.9 reading. This leaves the six-month annualized change in LEI at 4.3 percent, firmly in expansionary territory and indicative of an economy with continued momentum. The upward move follows a month-over-month decline in January — the first negative month-over-month drop since February 2021. That decline led some to wonder about a negative change in the direction of the index, which is a composite of 10 leading economic indicators.  

In the latest LEI, numbers for jobless claims, average work week, the interest rate spread and new orders offset poor scores for consumer expectations and building permits. The Conference Board’s Coincident Economic Index (CEI), a measure of current economic activity, also rose, by 0.4 percentage points to 110.3. A negative spread between LEI and CEI values historically has been an indicator of a slowing economy and potential recession, but February’s reading here is still firmly positive and expansionary. We will be watching for how the Russia-Ukraine war affects this indicator. 

The week ahead  

Swift changes in the war in Ukraine, as well as the world’s equally fast-moving responses, could upend markets positively or negatively at any moment. Coupled with ongoing news on the inflation front, market volatility is likely to be a fact of life for the foreseeable future. Here are some potentially market-moving developments to note this week:  

• Monday: Fed Chair Powell speaks to the National Association of Business Economists, perhaps shedding more light on the central bank’s upcoming moves.  

• Thursday: We get a look at the country’s employment situation with the release of data on initial and continuing jobless claims. We’ll also get February durable and capital goods orders and flash manufacturing and service PMIs from Markit. Forecasters anticipate slightly weaker manufacturing numbers and a slight improvement in services.   

• Friday: The University of Michigan releases its final report on March consumer sentiment.   

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