Yield and income: March came in like a lion, came out like a hawk
Investors started the month grappling with monetary policy uncertainty and inflation threats, coupled with geopolitical uncertainty and an escalating military conflict in Eastern Europe. During testimony to Congress on March 2, Federal Reserve Chairman Jerome Powell signaled the imminent start of the Fed’s first rate hike campaign in more than three years. February’s jobs report showed the economy adding 678,000 jobs, with the unemployment rate falling to 3.8%, allowing the Fed to focus more on the “price stability” part of its double mandate. A week later, February’s CPI reading of 7.9% only underscored the sense of urgency.
Meanwhile, inflation fears have been heightened by soaring oil prices, as sanctions on Russia create disruptions in European energy supplies. At its March 16 meeting, the Fed raised rates by 25 basis points (bps) and released consensus projections higher than expected. That set investors on the path to more hawkish expectations for Fed policy this year, driven by post-meeting comments from Fed officials, including Powell. Market projections for the year-end federal funds rate rose to 2.3% from around 1.3% at the start of the month. The 10-year Treasury yield, which had fallen towards 1.8% at the end of February, jumped to 2.5% before falling back in the last days of March. And the 2-year yield jumped to nearly 2.4% from 1.4%.
However, as bonds tumbled, stocks rebounded in the second half of March, driven by a number of factors. These include the inference that a more aggressive Fed rate hike cycle reflects confidence in the strength of the economy, hope that growing signs of a Russian-Ukrainian standoff will lead to a deal ceasefire and a more stabilizing trend in oil prices.
Against this backdrop, the equity-focused yield and income sectors outperformed in March, led by REITs, large-cap growth stocks and large-cap value stocks. Most fixed income sectors posted losses, including higher quality corporate bonds, where valuations improved. This month, we have raised the sector to neutral. The heightened level of uncertainty and volatility that has characterized 2022 so far highlights the need for a diversified holistic approach to investing. The return-oriented strategic asset allocations (SAAs) presented at the end of this report have been designed with this in mind.
At CIO, we believe there is now a wider range of potential outcomes in investment prospects and an unusually high degree of uncertainty. We are therefore now neutral on risky assets; however, our outlook is not negative. The Fed will likely raise rates by at least 25 basis points at each of the next six meetings, and we expect the US economy to remain resilient to absorb these inflation-fighting rate hikes. This backdrop would still support equities. In fixed income, higher rates and wider credit spreads led to improved valuations. 1
Main contributor: Frank Sileo
The content is a product of the Chief Investment Office (CIO).
For more information, please ask your financial advisor for a copy of the report, “Yield & Income: Cross asset ideas for yield”, published March 30, 2022.