Financial markets fail to find footing in February

Stocks took a breather in February after a strong start to the year. Technology was the only positive sector in February, rising 0.4%. Energy was at the bottom of the pack with a 6.9% decline as oil prices fell in February. Utilities had the second worst performance in February, falling 5.9% as many utility stocks, often regarded as bond substitutes, faced growing competition from US treasury yields.

What made February different than January?

Primarily three things: stubbornly strong labor market, hotter than expected inflation, and strong consumer spending.

Investors received a strong jobs report with the U.S. unemployment rate falling to its lowest level in over 50 years. With that being said, wage growth in excess of 2% inflation without reasonable productivity growth will make for an inflationary regime. Last year’s poor productivity growth contributed to imbalances between demand and supply, adding upward pressure on inflation. Policymakers are concerned the labor market could remain tighter for longer, placing upside risks to inflation.
Core inflation, stripping out volatile energy and food prices, increased 0.6% in January from a month ago, representing the fastest monthly clip in seven months. This pushed the annual rate of inflation to 4.7% from an upwardly revised 4.6%. Given the most recent reading, the Fed will continue its rate hiking campaign for a lot longer than economists anticipated just a few weeks ago.
Robust consumer spending in January caused real personal spending to rise 1.1% as consumers were seemingly unfazed by the inflationary landscape. Present Fed policy has yet to fully impact consumers, showing the policymakers have more work to do in slowing down aggregate demand. The Fed may still decide to hike by 0.25% at the next meeting, but this report suggests they will likely continue hiking into the summer.

The stronger-than-expected economic data caused interest rates to resume their march higher as seen here:

US Treasury yields eclipsed 5% for the first time since July 2007. Rates on the 6-Month and 1-Year Treasury Bills at the end of February were 5.17% and 5.02%, respectively. The 10-Year Rate was the lowest on the yield curve for the second straight month, but its 3.92% yield as of February’s end represents an 11.4% month-over-month increase.

Summary

The markets had been anticipating that the Federal Reserve was nearing the end of the interest rate hike cycle, possibly as soon as May, and had even been projecting rate cuts prior to the end of the year. With this new data, now many economists project that the timing of reaching the terminal rate (the end of the interest rate hikes) has been pushed back and will be at a higher level than previously thought. In addition, consensus estimates have now delayed any rate cuts from happening until 2024.

As a result, February felt a little bit more like a continuation of last year and made January feel a little more like just another bear market rally. Although a notable comparison, we are getting closer to the end, and the worst is likely in the rearview mirror but cannot be guaranteed.

It is altogether possible that February’s pullback provided some health to the markets after January’s rampant runup and gave investors, especially long-term investors, a chance to reconsider their portfolios’ positioning in anticipation of brighter days ahead.

We will have to wait for new economic data and the reaction of the Federal Reserve before we can truly know what comes to fruition and when.

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Monthly Market Recap – February 2023

Financial markets fail to find footing in February