Financial markets do not like uncertainty in any form. Uncertainty regarding fiscal policy, monetary policy, geopolitical tensions, and public health crises, just to name a few, make financial asset modeling and valuation even more challenging. Uncertainty is risk, and when it’s elevated, healthy two-way market flows can — and likely will — dissipate.
This is an appropriate characterization of what we have experienced so far in 2022, and as discussed in last month’s commentary, volatility could remain elevated until we get a clearer picture of the inflation outlook and the Fed’s subsequent response via interest rate and balance sheet policy. However, the worsening situation in Ukraine and questions surrounding Vladimir Putin’s ultimate military intentions have inflamed what were already-volatile markets.
Heightened uncertainty has weighed on financial markets in 2022, and the escalating conflict in Ukraine presents new complexities to the domestic and global economic outlooks.
The Fed is set to raise the federal funds rate at the March 16 FOMC meeting. Fed chair Jerome Powell said the economic impact of the Russian invasion of Ukraine remains “highly uncertain.”
The U.S. economy remains on strong footing as it approaches the end of Q1, but elevated financial market volatility could persist in the near-term due to uncertainty related to monetary policy and geopolitical events.
The Fed has a difficult job ahead. The situation in Ukraine and Europe only adds complexities.
January inflation readings set new multi-decade highs, and prior to Russia’s invasion, markets were pricing for an aggressive response from the FOMC with regard to rate hikes and balance sheet reduction. As a result, bond yields surged higher, particularly in the front-end and belly of the yield curve, and fixed income spreads widened sharply.
Prior to Russia’s invasion of Ukraine, the bond market was pricing in 150 basis points (bps) of rate hikes in 2022, including a high probability of a 50 basis point rate hike for the initial liftoff at the March 16 FOMC meeting. However, as the situation in Europe deteriorated, a global flight-to-quality trade sent short and intermediate Treasury yields 20-27 bps lower, and the market is now pricing for one less rate hike in 2022.
This market commentary is provided by ALM First Financial Advisors, LLC, the investment advisor for Trust for Credit Unions. Visit trustcu.com to read about the latest economic data and overall market trends.