The week that was

The relative calm that markets had enjoyed during most of the Ukraine war broke last week, perhaps reminding us that financial conditions remain a key concern for markets in ways that are often less obvious than attention gapping geopolitical headlines. Tech stocks bore the brunt of the selling which started on Tuesday when the minutes from the last US Federal Reserve meeting revealed so-called ‘quantitative tightening’ would have to accelerate to head off mounting inflationary pressures in the US economy and that short-terms rates would have to rise faster. Market reaction has focused on the former, less well understood measure and, as we discuss this week with Andrew Hunt, its implications for equity markets are likely to be quite pronounced even if the impact on the real economy is perhaps less well understood.

Quantitative easing (central banks buying long-term bonds) has been used primarily to hold down long-term interest rates in order to promote economic activity, although many suspect it has done more to increase asset prices (and especially real estate and large technology shares). The market has taken the Federal Reserve at its word about raising interest rates and short-term bonds around the world have risen sharply (even in Australia where our own central bank is still circumspect having only last week started to talk about tightening policy this year). Until this the market appeared less convinced about quantitative tightening but a host of Fed Committee members, many of whom have advocated for easier policy, reinforced the idea that ‘quantitative tightening’ was also going to happen sooner rather than later. That sent 10-year bond rates up another 0.3% during the week (and by similar margins around the world). That is the biggest weekly rise since 2019 but to see a comparable and consistent shift for the year to date of 1.3% (and 1-1.5% around the rest of the world) you would have to go back to the early eighties.

That was enough to put the Nasdaq very much on the back foot and the index was down 4% for the week with bellwether US tech stocks like Apple, Google, Microsoft and Amazon down by a similar amount. The rest of the market fared better and the broader S&P 500 and MSCI World Indices were only down by around 1%, helped by strong returns from defensives like healthcare,        consumer staples and Utilities as well as energy stocks. In contrast to previous value rotations, banks were noticeably absent signifying the increased probability of a recession ‘the US has to have’ (banking businesses can benefit from a rising interest rate environment but they are also economically sensitive). Similar patterns were observed in the local market with the defensive sectors outperforming, except that local banks kept their ground and consumer discretionary stocks, iron ore producers and Block (which has just bought Afterpay) kept the index just in negative territory.

One place where recession concerns have not appeared is in the corporate bond market which remains soft for the year but, all things considered, quite calm. Last week actually saw spreads (how much compensation investors demand for default risk) reduce very slightly. For now at least bond markets seem to believe the Fed will manage to engineer a soft landing even if it means higher interest rates in the short-term.

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