Holbrook Insights

The front end of the yield curve continued its rise last week, lifted by hotter-than-expected inflationary data.The inversion between the 2- and 10-year U.S.Treasury yields expanded to 50 basis points (bps) and the spread picked up another 8 bps between the two yields. The inversion reflects the Federal Reserve (Fed)’s efforts to cool near-term demand and the economy by raising the shorter-term debt beyond longer-dated debt. The 2-, 5-, 10-,and 30-year Treasuries moved 20 bps (to a 4.50 yield level), 13 bps (to a 4.27 yield level), 12 bps (to a 4.01 yield level), and 13 bps (to a 3.98 yield level), respectively.

The September employment report showed 263,000 jobs added during the month, which helped drive the unemployment rate down to 3.5 percent. This development further supports the Federal Reserve (Fed)’s trend of outsized interest rate hikes, as a higher unemployment rate is likely required to see meaningful cooling of inflation. As we approach the Fed’s November 1–2 meeting, the debate continues between those who think more must be done to fight stubbornly high inflation and those who think rates may be increasing too quickly for the economy to handle.

Equity sold off again last week, marking it the sixth week in the last seven to post a loss. The catalyst in aggressive Fed tightening remained in place as the sell-off that has persisted over the last month. The S&P 500 fell by 9.34 percent in September as the FOMC hiked another 75 bps, marking the third straight hike of this magnitude. Additionally, the FOMC moved up its rate expectations for 2023, which are now closer to 4.5 percent. The federal funds rate currently sits between 3.00 percent and 3.25 percent, indicating that the FOMC expects to continue to hike in upcoming meetings.

The equity market continued to feel pain as the Fed remains steadfast in its efforts to fight inflation. In his eight-minute speech last month, Chair Powell highlighted that there may be some short-term and this is what we’ve seen in the markets the last two weeks—particularly in small- caps and growth stocks since they are more susceptible to higher rates as higher costs of doing business lead to compression in valuations and future growth potential. Equity investors flocked to save haven areas in consumer staples, utilities, and health care as cyclical growth stories in energy, consumer discretionary, and REITs came under heavy selling.

The market sold off heavily again last week as short-term borrowing rates increased when the August CPI came in higher than expected. As a result, the Fed has more work to do in terms of raising rates and cooling off consumer demand to drive inflation lower. Short-term rates also dramatically reacted to this data. Additionally, it was announced on Thursday that FedEx, one of the largest international shippers, pulled its guidance for next year amid lower shipment volumes and overall economic uncertainty. The worst-performing sectors—which put a premium on lower rates of borrowing to fuel future growth—were technology, communication services, industrials, and consumer discretionary. The sectors that held up best amid the sell-off were energy, utilities, materials, and real estate.

The market rallied last week after falling in each of the previous three weeks. Economic news remains robust, leading investors to believe a 75 bps increase to the federal funds rate is increasingly likely at this month’s meeting. Due to this thinking, investors entered the market as a faster increase in rates from the Fed could potentially mean hitting the target sooner and cooling off inflation. Inflation linked sectors understandably struggled, with energy and consumer staples being the two worst-performing sectors.

The markets sold off again last week as they continue to give up post-June rally gains following a reiteration of tighter policy from the Fed. Global central banks echoed this sentiment with the European Central Bank widely expected to hike 75 bps this week. The continued tightening by developed market central banks has led to concerns around overall global growth. As a result, markets maintained their recent risk with utilities, health care, communication services, and consumer staples as the top-performing sectors last week. Materials, technology, and REITS underperformed, and semiconductors sold off as the U.S. announced a ban of advanced AI chips to China. Nvidia (NVDA) was hit hard—selling off more than16 percent—and American Micro Devices (AMD) fell more than 12 percent. Walmart (WMT), Target (TGT), and Dollar General (DG) outperformed while health care names such as McKesson (MCK), Abbott Labs (ABT), and Cardinal Health (CAH) also fared well. 

Equity markets took a break from their recent rally last week as commentary from Fed members James Bullard and Esther George signaled a continued need to keep rates elevated to further slow inflation down. As a result, the inflation-oriented sectors—consumer staples, utilities, energy, and health care—held up best while communication services, materials, REITs, and financials underperformed. Communication services has seen a slew of streaming providers raise prices due to a recent focus on monetization and content.