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Market Recap

March 01, 2023

The interest rate guessing game continues! Our last newsletter focused on a batch of data that suggested the Federal Reserve (the Fed) may be winding down its policy of aggressive interest rate hikes. That policy was arguably the single largest contributor to last year’s market volatility and decline. The possibility of interest rate “normalization”, based on that data, drove gains for the first half of February.

This time around recent data suggests the Fed may continue battling inflation longer than previously expected. The resulting interest rate increases could in turn drive short-term market losses. Let’s take a closer look at that data.

The labor market continues to defy expectations. The February 16th jobs report again surprised most economists with a decline in jobless claims – evidence that the economy is still strong despite the Fed’s rate hikes. (The Fed would like to see an increase in jobless claims or a decrease in the number of job openings because that could signal an ease in wage pressure.) The surprise report sent stocks tumbling, with the Dow Jones Industrial Average (the Dow), the S&P 500 Index (S&P 500), and NASDAQ Composite Index (NASDAQ) all closing over 1% down for the day.1 

On February 22nd the Fed released minutes from their recent meeting, concluded on February 1st. Those minutes confirmed that inflation “remained well above the Fed’s 2% target and the labor market remained very tight, contributing to continuing upward pressures on wages and prices.”2. The Fed comments also indicated that members believe “ongoing” rate increases will be necessary.   

Further fueling market volatility were comments made by St. Louis Federal Reserve President James Bullard. Not only did he advocate for a 50 basis-point (0.5%) interest rate hike at the February meeting (the Fed raised rates by 25 basis-points or 0.25%) but he also said he could see a hike of that magnitude at the Fed’s next regular meeting in March.3 

Other recent data showed a continuing high level of consumer spending despite elevated interest rates and a surprisingly strong and resilient economy. Once again positive economic news is pushing markets lower.

Aside from interest rates, the other guessing game on Wall Street is whether the Fed actions will tip the economy into a recession. Brendan Murphy, head of core fixed income, North America at Insight Investment said a recession is not necessary to achieve the Fed’s 2% target for inflation. “While a recession would almost certainly hasten the return of inflation to target, it should not be considered a necessary condition.” He continued, “We are now in a period of low growth and moderating inflation…the big question is how far can inflation come down in that type of environment. It is possible that if supply pressures continue to abate in a period of below-trend growth, inflation will eventually return to the Fed’s target. However, this period of below-trend growth might need to be quite long, which is why the Fed is talking about keeping rates restrictive for an extended period.”4

Or, putting it more simply: the likelihood of a recession depends on the Fed’s strategy. A recession is not a foregone conclusion, but the Fed may choose that route for a quicker resolution to our inflation problem. Thankfully, nearly all economists agree that if we do see a recession it will likely be slight and short-lived.

Reviewing returns for the second half of February, the major markets all declined. As of February 28th, the Dow fell 1,471 points (4.31%), the S&P 500 lost 177 points (4.28%) and the NASDAQ dropped 615 points (5.1%).

1 “Dow closes 400 points lower as hot inflation report, comments from Fed’s Bullard raise rate hike fears” February 16, 2023

2 “Fed minutes show members resolved to keep fighting inflation with rate hikes” February 22, 2023

3 “Dow closes 400 points lower as hot inflation report, comments from Fed’s Bullard raise rate hike fears” February 16, 2023

4 "Stocks close higher Thursday, S&P 500 snaps four-day losing streak" February 23, 2023

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment. The material presented is provided for informational purposes only. Past performance is no guarantee of future results. No person or system can predict the market. There is no guarantee that any strategies discussed will result in a positive outcome. All investing involves risk and no investment strategy can guarantee a profit or protect against loss, including the potential loss of principal. S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market. The NASDAQ is an index that tracks the cumulative results on a market capitalization basis of all stocks trading in the NASDAQ system. The Dow Jones Industrial Average is a widely watched index of 30 American stocks thought to represent the pulse of the American economy and markets. Investors cannot invest directly in an index. Diversification does not guarantee a profit or protect against a loss.