Baker Market Update – wk220128

It was another volatile week in the markets. Stocks are set to close with their fourth weekly loss and bond yields have bounced around as they digest the Fed’s plans to raise the Fed Funds Rate in March and reduce the $7 trillion balance sheet. Looking at the Treasury market, we are continuing to see a flattening of the yield curve as short-term interest rates are moving faster than long term rates. The 10Yr went up to 1.87% as of Wednesday’s close since retracing back to 1.80% Friday morning. The long bond (30Yr) is currently trading at 2.10%, down 10bps from the high made earlier this year and still 30bps lower than the peak in 2021. The 2Yr Treasury yield made a larger move starting the week sub 1% and now climbing as high as of 1.20%. Looking at the spread between these two rates, the 10s/2s are now at 63 basis points which peaked to 130bps in the Fall of last year. This creates a unique situation for the Fed hiking into a relatively flat curve versus prior economic cycles. It was a busy week with economic data and continued geo-political issues between Ukraine and Russia.

In the middle part of the week the Federal Open Market Committee had their January meeting and signaled it would begin steadily increasing interest rates beginning at March meeting. Chairman Powell indicated they are ready to move steadily away from highly accommodate policy given they’ve reached the employment goals and are more concerned with the elevated inflation they have been dealing with since earlier last year. When asked about their intentions of forward guidance on the path of the rate hikes this year, Chairman Powell suggested the Fed wasn’t likely to offer any which contrasts with the rate hiking cycle back from 2015 to 2018. Rates traders are currently pricing in four hikes this year.

On Thursday GDP was released showing the US economy grew rapidly at 6.9% annual rate, capping the strongest year of growth in nearly four decades. Adjusted for inflation, this quarterly print exceeded most expectations of around 5.5% and improve significantly from the slow down of 2.3% in the third quarter last year. Looking at this year, most economist think output will grow at a more moderate pace. Thursday’s report did show the majority of the growth components were related to firms restocking inventory versus consumers and firms purchasing new inventory and equipment. Today’s releases included the University of Michigan Sentiment Survey which dropped to lowest level in decades based on Omicron fears and the BLS released the Employee Cost Index which showed that firms spent 4% or more on wages and benefits last year showing some of the highest pay increases seen in over 20 years.

Looking at next week’s economic calendar there will be plenty for the markets to digest relating to manufacturing, housing and jobs. On Monday, the Dallas and Chicago Fed will release their PMI and Manufacturing indices, respectively. On Tuesday we see the Institute of Supply Chain Management (ISM) release their manufacturing data and also the BLS will release the JOLTS (Job Opening and Labor Turnover Survey). Housing data from the Mortgage Bankers Associations will be released on Wednesday. And finally on Friday we will get the key jobs report for the month of January which will tell us if the unemployment rate will continue on its trajectory of 3.5% (from currently 3.9%). Have a Great Weekend Everyone!

GDP Breakdown by Quarter

Source: Bloomberg & BEA (Bureau of Economic Analysis)

4th Quarter GDP was well beyond expectations but under neath the data it shows some potential future weakness. For example, more than two thirds of the growth was concentrated in inventory investment.

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