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The Fed remains committed to fight inflationary pressures

U.S. equities were lower this week, with the S&P 500 and Nasdaq declining for the second straight week. Growth and value were down. The Dow Jones Industrial Average decreased 282 points or 0.9% to 32,920, the S&P 500 Index fell 1.1% to 3,852, and the Nasdaq Composite decreased 105 by 1.0% to 10,705. WTI crude oil lost $1.82 to $74.29 per barrel. Elsewhere, the gold spot price rose $14.30 to $1,802.10 per ounce, and the Dollar Index went up 0.1% to 104.69. Markets ended lower for the week, as the DJIA declined 1.7%, the S&P 500 fell 2.1%, and the Nasdaq Composite dropped 2.7%. All sectors finished in negative territory for the week . Treasuries ended the week firmer with the curve flattening, USYC2Y10 Index -70.24bps. The dollar index ended the week nearly unchanged from the prior week. Wall Street analysts expect that 2022’s earnings growth rate for S&P 500 companies will average 5.1%, according to FactSet a significant decrease from the past 10 years average earnings growth of 8.5%. 


CPI inflation data for November came in below expectations, with headline inflation of 7.1% year-over-year versus expectations of a 7.3% figure. Core inflation came in at 6.0%, also below forecasts of 6.1% and lower than last month's 6.3%. Overall, inflation is moderating but still too high and well above the Fed's 2.0% target. Inflation is expected to lessen in December as gasoline medical and transportation services prices continue to fall. High rates began to influence demand for goods in November, as indicated by the lower prices in electronics and household items. As supply shortages ease and interest rates remain high, analysts expect prices to moderate in the upcoming months. Core services prices increased by only 0.4% in November. Services prices were weighed down by a 0.7% MoM decline in medical care services, driven downward by a sharp decline in health insurance and a decline in hospital prices in November. Travel-related services also declined, as hotel room, car rental and airfare prices declined. As high interest rates continue to reduce consumer purchasing power, we expect services demand to gradually decrease, slowing core inflation overall. However, shelter and rent prices remained elevated again. Rent increased by 0.8% MoM, and owner’s equivalent rent increased by 0.7% MoM. However, the shelter component tends to have a significant lag.


As expected on Wednesday, the Fed unanimously raised the Fed funds rate by 50 basis points in a move that was well telegraphed and anticipated by the markets. Rates now are well into restrictive territory, and it’s expected to negatively affect demand. Fed Chair Powell said that while recent inflation data has been encouraging, inflation remains elevated and well above the Fed's 2.0% target. Fighting inflation remains top priority and not the impact of higher rates on economic growth. The dot plot within the Fed’s Summary of Economic Projections showed an elevated terminal rate of 5.1%, slightly higher than the expected 5.0% for 2023. Last week, the Bank of England, the Swiss National Bank and the European Central Bank (ECB) also raised their policy rates by 0.50%, bringing the target rate to 3.5%, 1% and 2.0% respectively. Almost all major central banks reiterated that further rate hikes are likely, as inflation remains well above target ranges.


U.S. Treasuries ended the week with 10- and 30-year bonds recording moderate loses. Regarding Treasuries, we think near-term concerns regarding recession may keep yields rangebound. President Biden signed a continuing resolution to fund the government for a week, giving lawmakers more time to reach an agreement on a broader funding package. The EU announced a new package of sanctions against Russia. The U.S. Senate failed to pass Senator Manchin's energy permitting reform and the Biden administration announced a plan to replenish three million barrels of oil for the strategic petroleum reserve. Although China recently lifted some of the coronavirus restrictions, the country’s economic reopening is expected to be uneven. Reports have noted that economic activity remains depressed as concerns about the virus’s spread discourages people from returning to work and their normal activities.  Previous restrictions and recent surge in new COVID cases in the region are causing labor shortages to businesses.


Equity and bond market volatility will remain elevated until there’s a sustained decrease in inflation, and higher rates will remain for longer as “data-dependent” Fed focuses on the effects of rate hikes. We remain defensive in our positioning, and we’d look for opportunities to upgrade portfolios during market weakness. In the near-term value and defensive sectors of the economy may continue to lead. Investors should consider using periods of market volatility to rebalance, diversify, and add quality investments at potentially better prices from both value and growth parts of the market. We favor quality, yield and lower cyclicality. For fixed income, we recommend a barbell positioning, with an overweight to short- and longer-dated bonds. We remain defensive in our credit positioning, with short duration, and higher in credit quality. We expect credit spreads to remain extensive. But as the economy goes through a downturn during the first half of 2023, market leadership may shift toward the sectors of the economy that tend to do better during recovery periods. This includes areas like quality growth and cyclical sectors, and investment-grade bonds.

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