Second Quarter 2022 Update

August 1, 2022

Key Points

• To combat the highest inflation rate in more than 40 years, the Federal Open Market Committee (FOMC) raised its federal funds rate target range twice during the quarter, to 1.50% to 1.75%, from a range of 0.25% to 0.50%.
• The US economy slowed precipitously in the quarter, as the Russian invasion of Ukraine and significant swings in inventory accumulation put a damper on growth.
• The May report showed that employers added 390,000 jobs in the month, and that the unemployment rate fell to 3.6%.

2cd QUARTER 2022 MARKET COMMENTARY

Below, we’ve highlighted 2022 broad market returns for the second quarter and year-to-date time periods:

Source: Refinitiv

THE GLOBAL ECONOMY

The US economy slowed precipitously in the quarter, as the Russian invasion of Ukraine and significant swings in inventory accumulation put a damper on growth. Against this backdrop, the Bureau of Economic Analysis released the third estimate of the first quarter 2022 real GDP, a seasonally adjusted annualized decline of 1.6%, slightly lower than the prior estimate, but a material deterioration from the 6.9% increase in the prior quarter. The employment situation once again surprised on the upside in the quarter, as gains exceeded expectations. The May report showed that employers added 390,000 jobs in the month, and that the unemployment rate fell to 3.6%. The Federal Open Market Committee (FOMC), to aggressively battle surging inflation, twice raised its federal funds rate target range in the quarter, to 1.50% to 1.75%, from a range of 0.25% to 0.50%. The 75-basis point increase on June 15th was the first since 1994, and many economists expect the FOMC to continue to aggressively raise rates until inflation is under control.

EQUITIES

The decline in stock prices accelerated in the second quarter as the FOMC moved to aggressively raise interest rates to combat historically high inflation. Investors are becoming increasing concerned about the potential for a recession, and consequently have adopted a pessimistic outlook on stocks. In addition, supply chain bottlenecks continued to cause supply bottlenecks, and the ongoing war in Ukraine has created issues in the energy and agriculture segments of the global economy. Similar to the previous quarter, the S&P 500 peaked on the second trading day of the quarter, declined steadily into the middle of May, and then stabilized somewhat before heading lower again.  Many major stock indices entered bear market territory (a decline of at least 20%) in June. When the quarter ended, the S&P 500 Index had declined 16.1%, and is down 20% year-to-date.  The MSCI EAFE Index of developed markets stocks were lower by 14.5%, as were emerging markets stocks, with the MSCI Emerging Markets Index falling by 11.5%.

FIXED INCOME

To combat the highest inflation rate in more than 40 years, the Federal Open Market Committee (FOMC) raised its federal funds rate target range twice during the quarter, to 1.50% to 1.75%, from a range of 0.25% to 0.50%. The 75-basis point increase on June 15th was the first since 1994, and many economists expect the FOMC to continue to aggressively raise rates until inflation is under control. The committee’s statement accompanying the most recent increase included language that the FOMC is “strongly committed” to bringing inflation to its 2% objective. In addition, the statement lacked reference to the job market also being a concern. Analysts point out that even though the FOMC has begun to raise rates aggressively, monetary policy is still very accommodative since high inflation means the real fed funds rate is negative.  The FOMC’s “dot plot,” a forecast of future rate changes, indicates the committee now expects the fed funds rate to be at 3.375% at the end of this year, and 3.8% at the end of 2023.

SUMMARY

US consumers and investors have become increasingly pessimistic this year because of historically high inflation, the FOMC’s aggressive interest rate increases, and the war in Ukraine, among other things. High inflation continues to be the biggest challenge confronting the world’s policymakers. Analysts believe the volatility in global commodity markets – including both energy and food products – likely means that above-target inflation will remain throughout 2022. As a result, world central banks have begun to tighten monetary policy after more than a decade of quantitative easing. Restrictive monetary policy is not always an effective tool to dampen inflation resulting from supply-side pressures, and a primary concern with rising interest rates and tighter monetary policy is recession. The consensus among economists is that the US economy has only about a 50% chance of a recession in the next two years due to strong economic fundamentals, but nervous consumers and investors waylaid by the combination of rising interest rates and high inflation could see additional asset valuation erosion. There are several potential downside risks outlined by economists, including a continuation of the negative supply shock resulting in part from the war in Ukraine; the potential for spread of future Covid variants; the global semiconductor shortage; and property market weakness in countries where real estate valuations have been surging.

Information provided is for informational purposes only and should not be construed as investment advice. The views expressed are current only as of the publication date, are based on information that St. Clair Advisors believes to be accurate, and subject to change without notice. All investment decisions must be evaluated as to whether they are consistent with your investment objectives, risk tolerance and financial situation. St. Clair disclaims any liability for any direct or incidental loss incurred by applying any of the information in this publication. Indexes are unmanaged and one cannot invest directly in an index. Past performance is no guarantee of future results.

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