Higher Inflation, Higher Rates and Lower GDP shaped the markets in April
Economic uncertainty and rapidly rising interest rates impacted stock and bond markets in April. The GDP report for the first quarter came in negative for the first time since early in the pandemic. The 10-year Treasury yield, an important gauge of the level of interest rates, rose from 2.34% to 2.94% over the month, the highest since 2018. This drove the market lower, with the S&P 500 declining -by 8.8% during the month, the Dow 4.9%, and the Nasdaq 13.3%. This places the S&P 500 back into correction territory (a 10% or worse decline from the peak) and the Nasdaq in a bear market (a 20% or worse drop). The VIX index of stock market volatility jumped to 33.4 in response to these large market swings.
Here’s what investors need to know:
- Economic growth slowed in the first quarter of the year, based on a report of gross domestic product (GDP), a measure of economic activity. Specifically, the country’s GDP fell by 1.4% on an annualized basis when compared to the previous quarter. This was worse than expected but was driven primarily by a worsening trade deficit, reduced government spending, and changes to business inventories. Other underlying trends were still strong, including consumer spending, which grew 2.7%, a good sign for businesses.
- Higher interest rates are filtering across the economy. The interest rate on the 10-year Treasury is nearing 3% for the first time since 2018. Rising rates are a double-edged sword. On the one hand, savers are finding much better yields on many bonds. However, this can make borrowing more expensive for homebuyers and others. The average 30-year fixed mortgage rate has risen from 3.27% at the start of the year to 5.3%, the highest since the global financial crisis in 2008. Major indices fell in response to these rate shocks.
- The Fed will likely quicken its pace of rate hikes to battle inflation. The Fed’s expected 0.5% (half of one percent) rate hike in May could mark the beginning of faster increases in policy rates. The Fed knows it needs to hike faster to keep inflation in check as it broadens across the economy, especially as higher prices affect the pocketbooks of everyday Americans.
- However, it’s too soon to call for a recession. Other economic data are still positive, especially in the job market. Corporate earnings are strong and some companies have already generated positive surprises during this earnings season. Wall Street estimates suggest that S&P 500 earnings-per-share could grow by about 10% in 2022, and between 9 and 10% each of the following two years. If so, this would be well above historical averages and could help to support markets in the years to come.
Rebound or recession — it’s still a guess
Overall, investors have been expecting slower economic growth due to inflation, the war in Ukraine, higher rates, and other reasons for some time now. In fact, some market measures such as fed funds futures suggest that many investors may view persistent inflation as a bigger problem than higher interest rates, and thus may welcome more Fed rate hikes. Although major indices are in the red so far this year, history also shows that markets can rebound when investors least expect it. Thus, investors should stay disciplined and not overreact during this turbulent period.
Chart of the month: U.S. GDP for Q1 came in worse than expected at -1.4%, the first negative quarterly growth rate since the pandemic began.
Sources: Clearnomics, American Automobile Association, Nasdaq, Standard & Poor’s, CBOE, Federal Reserve, Bureau of Economic Analysis