Financial markets experienced a historic decline during the first half of 2022 as investors came to the realization that the war in Ukraine would contribute to an already grim inflation picture. Interest rates rose sharply in the United States and abroad, with ultra-low and negative bond yields to start the year offering little cushion against the steep price declines in the bond market. The Bloomberg U.S. Aggregate Bond Index declined by more than 10% during the first half of the year — and is on pace for the worst annual performance since its inception in 1976.
The outlook for Federal Reserve (Fed) monetary policy rapidly adjusted to the inflationary environment, with yields at the front end of the curve increasing by more than 200 basis points (bps) since the start of the year. The Fed moved more aggressively with each successive interest rate hike — 25 bps in March, 50 bps in May and 75 bps in June. Fed Chair Jerome Powell has promised to make inflation the Fed’s top priority after acknowledging that monetary policy was behind the curve on it.
The damage from high inflation was not limited to the capital markets as consumers and businesses faced challenges from rising prices. In the face of record-high gas and food prices, the University of Michigan Consumer Sentiment Index fell to record-low territory. Low- and middle-income earners are disproportionately feeling the impact of high prices for necessities. Additionally, the red-hot housing market is beginning to cool in response to mortgage rates more than doubling since the start of the year.
Following a 1% decline in real gross domestic product (GDP) growth in the first quarter, the Atlanta Fed is now forecasting another negative GDP print in the second quarter — suggesting the U.S. may already be in a recession. The economic slowdown is underway despite the U.S. unemployment rate hovering near its lowest level in 50 years.
The surge in inflation to levels not witnessed in more than four decades remains the dominant economic story this year. Despite Chair Powell’s assurances that the Fed will do whatever it takes to combat inflation, the Fed will need to tread carefully with its tightening policy as weakening economic growth prospects and risks to market stability move to the fore.
Even though we don’t foresee a dramatic U-turn in interest rates during the second half of the year, credit markets priced near the highest yields since the financial crisis of 2007-09 offer an attractive entry point. Our nimble, relative value-focused investment approach should also benefit from ongoing bouts of market volatility as liquidity conditions tighten.
Exhibit 1. 2021 and 6/30/2022 Actual; 2022 and 2023 Forecasts
*1-year as of 1Q22
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The views expressed in this material are the views of PMAM through the year ending June 30, 2022, and are subject to change based on market and other conditions. This material contains certain views that may be deemed forward-looking statements. The inclusion of projections or forecasts should not be regarded as an indication that PMAM considers the forecasts to be reliable predictors of future events. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate. Actual results may differ significantly.
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