RECAPPING LAST WEEK
Global equity markets remained remarkably resilient last week despite another sharp rise in
interest rates, elevated energy prices, and the first rate hike from the Federal Reserve in more
than three years. U.S. equities initially came under pressure following Wednesdays widely
anticipated 25 basis point increase in the Fed Funds target rate to 3.75%-4%, but the selloff was
relatively short-lived, with most major indices recovering from their knee-jerk response to the rate
announcement. The S&P 500 and Nasdaq remained close to their recent highs while the Dow and
Russell underperformed. The biggest focus remained on the Fed meeting and the implications of
the first rate hike since 2023. While the increase itself was widely expected (Fed Funds futures
were priced at a 93% probability), the Fed’s indication that another hike could come before year-
end pushed shorter-term Treasury yields higher, while longer-term yields were comparatively
stable. The resulting flattening of the yield curve reflected the market’s view that monetary policy
will remain restrictive even as longer-term inflation expectations appear more contained. Crude oil
prices finally showed some signs of easing, with Brent and WTI both pulling back as Saudi Arabia
indicated that additional production could return to the market. The decline in crude, however, has
not translated into lower prices for refined products, with U.S. diesel prices reaching another all-
time high well above $6 per gallon. The inelastic demand from the global trucking and shipping
industry, the additional seasonal demand from farmers during the fall harvest and the onset of the
heating season, combined with supply disruptions primarily related to the Russian Ukrainian war
have all created the perfect storm for this lifeblood of the global economy. The U.S. Dollar also
responded favorably to the Fed rate hike, including adding an additional leg up against the Yen
after the Bank of Japan matched the Fed’s rate hike with its own widely anticipated 25 basis point
hike on Friday. Crypto markets were also notably resilient despite the Senate’s failure to advance
the CLARITY Act. The legislation sought to establish a comprehensive regulatory framework for
digital assets by defining and delineating responsibilities between the SEC and CFTC. Shortly after
the bill failed in the Senate, the SEC issued an “Innovation Exemption” for the next five years
around Tokenized Securities Venues, which provided further support for the sector. In S&P
Sectors, Healthcare was the best performer while the rate-sensitive Utilities and Financial sectors
were the worst. Overall, the week continued to highlight the resilience of risk assets in the face of a
more challenging macro environment driven by higher rates and energy costs.
THE WEEK AHEAD
Investors will have a relatively light economic calendar to digest next week, leaving markets
focused on the signals that could influence expectations for another Fed Funds hike in October.
Futures markets are currently pricing in a 57% probability of a 25-basis point increase. The
Treasury market will provide an important real-time signal, particularly if short-term yields
continue to rise relative to longer maturities. A further flattening of the yield curve would indicate
that markets are increasing the probability of additional near-term tightening and growing
increasingly optimistic that the Fed will be able to slay the inflation dragon. The two-year is already
trading 88 basis points above the overnight effective Fed Funds rate, contrasted against the 2s-10s
spread which has flattened to 27 basis points. Of course, oil prices, largely driven by the
uncertainty surrounding the U.S.-Iranian conflict, remain problematic in dampening those inflation
expectations. As outlined above, the tightness in the diesel market has the potential to be truly
disruptive in the coming weeks. European politicians have jumped into the fray, threatening a
“windfall profits” tax on refiners, but that rhetoric will do nothing to solve for the upcoming
seasonal increase in demand combined with the reduction in refining capacity. Through it all,
equities have continued to hold their own in these upwind conditions, seemingly awaiting the day
that the macro environment provides a tailwind for the next leg of their journey.
(Schwab)
