Investors' attention is turning to the meeting of the Federal Reserve. An increase in the federal funds rate by 50 bps to +1.0% is expected on May 4th. In addition, the Fed will continue to anticipate that ongoing increases in the FFR will be appropriate (markets price-in circa 300 basis points of tightening over the next 12 months). Finally, the Fed is expected to announce the start of the reduction of its balance sheet (current: $8.9T or 38% of US GDP) by circa $1T per annum.
The pace of monetary stimulus removal will accelerate, as the US labor market is tight and inflation pressures are broadening. The US labor market report (due on May 6th) is expected to show that job growth remained robust in April, with non-farm payrolls up by 400k (+431k in March) and the unemployment rate at 3.6% (3.5% pre-pandemic).
The Employment Cost Index, a quarterly measure of the change in the cost of labor, free from the influence of employment shifts among occupations and industries, rose by +1.4% qoq (+4.5% yoy) in Q1:2022, above expectations for +1.1% qoq (+4.3% yoy), recording its largest quarterly increase since 1989.
The strong-demand/restrained-supply theme remains in place in the US, as also indicated by panelists’ comments in recent business surveys. In the event, the manufacturing PMI for April from the Institute for Supply Management remained elevated (55.4), even with a decline of 1.7 pts from March’s reading.
Business surveys in China, pointed to significant headwinds for economic activity from pandemic-related local lockdowns. Indeed, April PMIs stood well below the expansion/contraction threshold of 50 in both manufacturing (Caixin: 46 | NBS: 47.4) and the services sectors (NBS: 40).
The aggressive repricing of US real interest rates (above 0% for the first time since March 2020), alongside the protraction of international supply chain disruptions, exacerbated by the war in Ukraine and lockdowns in China, weigh on risk appetite. Major heavyweights’ (Amazon, Apple) earnings announcements also contributed to price weakness, either via disappointing Q1:2022 results or/and poor forward guidance.
In all, with losses of 9% in April, the S&P 500 recorded its worst monthly performance since March 2020 and with a -13% since the start of 2022 (as of April 29th), the worst 4-month start in a year, since 1939.
At the same time, government bond prices (US, Germany) have experienced their worst 4-month beginning in a year since 1974, with 10-year yields up by 138 bps to 2.89% and by 108 bps to +0.90%, respectively. Positive stock-bond correlation, if sustained, significantly lowers diversification benefits.
The US Dollar has appreciated substantially so far in 2022, on the back, inter alia, of monetary policy divergence as the Federal Reserve is expected to proceed with a much speedier tightening compared with the ECB (+7% ytd against the euro to $1.05, a 5-year high) and the Bank of Japan (+13% ytd against the Japanese Yen, to \129.56 as of April 29th, a 20-year high).