In this week’s Market Insights, we cover the ongoing events unfolding between Russia and Ukraine, the low duration benefits from bank loan exposure, and the decade’s low consumer confidence levels. In our Chart of the Week, we discuss higher short-term yields driven by rate hike expectations this year. Finally, we highlight the increase in inflation expectations partly driven by the increase in energy prices.
Top Weekly Themes
- Russia-Ukraine war continues – Geopolitical risks remain high as the Russian/Ukraine war entered its second week. Although the second round of talks between the countries was held, more sanctions were levied over the past week targeting Russia’s economy and financial system. The ruble has dramatically declined while Moody’s downgraded Russia’s long-term foreign debt rating to junk. Equity volatility as measured by the VIX reached a yearly high last week while U.S. bond yields have been whipsawed back and forth. The 10-year U.S. Treasury yield has been influenced by higher commodity prices and overall inflation, flight to quality trading, and potentially weaker economic growth. High levels of volatility are expected given the pace of new headlines impacting financial markets. At Bryn Mawr Trust (Bryn Mawr Trust), we are closely monitoring events but continue to believe our investment process is better rewarded for focusing on long-term implications and not getting caught up in the day-to-day market-moving headlines. Understanding current drivers of short-term market fluctuations but not overreacting to them continues to be a primary and very important theme across Bryn Mawr Trust investment strategies.
- Bank loans providing some interest rate protection – U.S. Treasury yields have been increasing across the yield curve this year leading to negative returns across most fixed income sectors. Longer duration bonds have generally been the worst-performing part of the yield curve given their increased price volatility. Shorter duration bonds have held up much better. For example, the Bloomberg Intermediate Government Credit Index was down -2.36% through March 2nd this year. The average duration is about 4.1 years. For comparison, the Credit Suisse Leverage Loan Index is down about -0.12% through the same period. Interestingly, the latter has notably more credit risk but has a duration of roughly 0.25 years, a positive when interest rates are rising. We continue to incorporate bank loans within Bryn Mawr Trust fixed income strategies that have non-traditional fixed income exposure. Default rates have been low and underlying fundamentals are expected to hold up reasonably well within a growing U.S. economy. Although credit risk certainly exists, the shorter duration asset class has provided some diversification benefits within the current higher yielding environment.
- Low consumer confidence levels haven’t deterred spending – Consumer confidence levels continued their downward trend this year and remain at a 10-year low according to the University of Michigan Consumer Sentiment Index. Inflation has been a top-of-mind concern for consumers over the past year and rightfully so. The last CPI report had annual inflation running at an abnormally high 7.5% through January. Interestingly, consumer spending has held up reasonably well in light of today’s inflationary environment. In January, Personal Spending increased at a healthy 2.1%, the highest in roughly 10 months. Goods spending was the primary driver, a familiar post-pandemic theme. The strong labor market continues to support consumers’ spending habits. The U.S. unemployment rate was at roughly 3.8% through February while companies continued to add more workers to their payrolls. Although we are monitoring geopolitical risks very closely, we continue to believe the U.S. economy is positioned for above-average growth this year supported by consumer spending.
|Russell 1000 Value||2.9||(3.1)||13.4||12.16||9.38||1.94|
|Russell 1000 Growth||5.4||(12.3)||11.3||22.91||20.10||0.73|
|MSCI EM (Emerging Markets)||(3.2)||(5.0)||(12.0)||6.30||7.31||2.47*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||0.3||(3.9)||(3.2)||3.15||2.72||2.42|
|Bloomberg Barclays US High Yield – Corporate||0.6||(3.7)||0.4||5.31||4.85||5.65|
|Bloomberg Barclays Municipal Bond||0.3||(3.0)||(0.6)||3.25||3.36||1.85|
|Bloomberg Barclays Global Aggregate x US (Country)||(0.5)||(3.4)||(7.1)||1.43||2.40||1.39|
|Crude Oil WTI (NYM $/bbl) Continuous||20.1||47.1||85.1||25.6||16.0||110.6|
|Natural Gas (NYM $/mmbtu) Continuous||3.5||34.6||66.5||18.7||11.3||4.8|
|Gold NYMEX Near Term ($/ozt)||0.6||5.1||10.8||14.0||9.3||1,920.9|
|Copper Cash Official LME ($/mt)||2.5||5.8||11.3||16.0||11.3||10,257.5|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.13||1.14||1.21||1.14||1.05||1.11|
|Japanese Yen per U.S. Dollar||115.04||115.16||106.73||110.90||114.40||115.58|
|U.S. Dollar per British Pounds||1.36||1.35||1.39||1.32||1.23||1.33|
Chart of the Week
2-year U.S. Treasury yield versus number of rate hikes expected by December 2022 Fed meeting
(November 30, 2021 – March 2, 2022)
Short-term yields have been on the move over the past few months as investors increased the likelihood of Federal Reserve (Fed) rate hikes this year. Based on federal funds futures activity, the market is currently anticipating nearly six rate hikes as noted by the red line in the chart above. The 2-year U.S. Treasury yield, the orange line, has trended higher and currently yields roughly 1.51% as of March 2. For those with excess cash, short-term investment options have certainly become more compelling.
A portfolio of individual short-term U.S. Treasuries with a maximum of one year and an average maturity of .5 years currently yields about 0.60% based on current yields. By extending the portfolio an extra year, the average gross yield is currently around 0.90%. After a period of very low short-term interest rates, the current interest rate environment presents a very good opportunity to get some excess cash to work at today’s current yields.
U.S. Breakeven 5 Year Rate (December 31, 2021 – March 1, 2022)
Inflation expectations have notably increased over the past couple of weeks on the heels of Russia’s invasion of Ukraine and its impact on the energy market. Concerns over oil supply disruptions in the wake of Russian sanctions and economic uncertainty contributed to futures for West Texas Intermediate (WTI) for delivery in April closing last Wednesday at $110.60, the highest level since May 2011.
Based on the above chart, investor expectations for annual inflation over the next five years increased from 2.80% earlier in the month to roughly 3.30% currently. The Fed is certainly paying attention and is prepared to begin raising rates at its March 16th meeting.
Fed Chairman Jerome Powell said as much when testifying to the House Financial Services Committee last Wednesday during his semi-annual testimony. The Chairman also went on to specify that larger rate hikes or consecutive meeting rate hikes were in the cards if inflation is more persistent than expected.
We continue to believe that rate hikes are appropriate given the federal funds effective rate is close to 0.00%. As we continue to move through 2022, we expect higher policy rates, improving supply/demand imbalances, and the disinflationary economic impact from rising energy prices to weigh on consumer prices. In our view, the Fed will likely have more flexibility when conducting monetary policy in the back half of the year when inflation is coming down from peak levels.