A New Reality
Signal Definer: Interrupted. The Russian invasion of Ukraine, the ongoing disruption of sanctions, historic inflation, a strong labor market, geopolitical uncertainty, and a Fed that remains committed to rate increases resulted in negative returns in both equities and credit markets.
February Market Recap
The S&P 500 Index returned -3.14%
The Bloomberg Barclays U.S. Aggregate Bond Index returned -1.11%
Fed Funds Target Range: 0 – 0.25%
Economic Review
Signal Definer: Interrupted. The Russian invasion of Ukraine, the ongoing disruption of sanctions, historic inflation, a strong labor market, geopolitical uncertainty, and a Fed that remains committed to rate increases resulted in negative returns in both equities and credit markets.
February Market Recap
The S&P 500 Index returned -3.14%
The Bloomberg U.S. Aggregate Bond Index returned -1.11%
Fed Funds Target Range: 0 – 0.25%
Economic Review
February opened with a strong January employment number as the Bureau of Labor Statistics reported an increase of 467,000 jobs. This only served to fuel speculation that a strong labor market would lead the Federal Reserve to be more aggressive with rate increases than previously indicated, in its attempts to control inflation. The release of the January average annual inflation number of 7.5% in mid-February proved to be a shock to the system.
Overnight, futures markets began pricing in a 50-basis point increase in March, and the two-year U.S. Treasury yield gained 24 basis points. This flattened the yield curve as the ten-year U.S Treasury struggled to get to 2%. The next step after flattening is to invert – which is usually interpreted as a sign of an impending recession. Investors’ worry was that more aggressive Fed rate increases would overshoot and stifle growth.
This was the backdrop as Russia’s build-up of a massive troop presence on Ukraine’s borders, and the West’s telegraphed response of the threat of sanctions unsettled markets further. And then Russia invaded.
Ukrainian President Volodymyr Zelenskyy’s reaction to the U.S. offer of help in evacuating his country was the now-famous “I need ammunition, not a ride.” The fierce resistance of Ukrainian Freedom Fighters and the resolve of its citizens slowed Russia’s advance and provided a window for the West to respond.
The sanctions playbook has been fine-tuned since last fall, and officials in many countries have had time to build the trust needed to impose sanctions that can counteract Putin’s long-honed measures to insulate the Russian economy from the impacts of Russian aggression.
• Western leaders have frozen the assets of Russia’s central bank, limiting its ability to access $630bn of its dollar reserves.
• The US, the EU and UK have also banned people and businesses from dealings with the Russian central bank, its finance ministry and its wealth fund.
• Selected Russian banks will also be removed from the Swift messaging system, which enables the smooth transfer of money across borders.
• The U.S. announced a ban on imports of Russian oil.
The impact of sanctions resulted in the price of a barrel of crude skyrocketing. Chairman Powell, in his testimony to Congress, acknowledged the difficulty of making monetary policy given the uncertainty of the situation, but he clarified that a 25-basis point increase would be coming in March, and referenced the strong labor market in explaining the Fed’s decision to stay the course and raise rates as planned.
The release of February’s employment number on March 4th backs this up. The Department of Labor reported that the U.S. added 678,000 jobs in February, and that unemployment had fallen to a pandemic low of 3.8 percent.
Market Review
The S&P 500 posted its first official correction since February 27, 2020. For the month, the market was down broadly, as only 1 of the 11 sectors gained, down from 10 last month and 2 the month before that. Energy did the best, as oil continued up, jumping 18.97% for the month. Financials was next, declining a minor (-0.08%), down (-2.92%) for the three-month period and up 35.02% for the one-year period.
The 10-year U.S. Treasury ended the month at 1.82%, and the two-year U.S. Treasury ended at 1.44%. The Bloomberg U.S. Aggregate Index was down, returning (-1.11). As represented by the Bloomberg Municipal Bond Index, Municipal bonds returned (-0.35%). The high correlation of the high-yield bonds to equities and the market shift to risk-off resulted in a return of (-1.02%) for the Bloomberg U.S. High Yield Index.
Leveraged loan market volatility over the last three weeks of February left the S&P/LSTA Leveraged Loan Index with a negative return year-to-date, wiping out the solid start for the asset class at the beginning of the year. The February return is negative (-0.49%).
While the loan market has hit a rough patch these past several weeks, money continues to flow into U.S. loan funds, with $912.5 million added in the week ended Feb. 23, bringing the year-to-date total inflow to $13.2 billion.
Middle market CLOs saw improving credit metrics in the fourth quarter, according to Fitch Ratings. This included declining exposure to triple-C and defaulted assets. The average exposure to loans rated CCC+ or below fell 0.8%, to 11.9%.
