Bets on cooling inflation and lower rates proved misplaced in February and investors hit the sell button across assets.
(Bloomberg) — Bets on cooling inflation and lower rates proved misplaced in February and investors hit the sell button across assets.
From stocks to fixed income and commodities, just about everything fell in a reversal of January’s spirited rally. Shelter was hard to come by: the least-bad return among major US assets was a decline of 1.4% through Monday from high-yield bonds. That was followed by a drop of roughly 2.5% each in Treasuries and the S&P 500 Index, a 3.2% slide in investment grade and a 5% slump in commodities.
While other periods have been far worse for specific sectors, the pervasiveness of losses was notable. During the past four decades, only one other month has seen the best return among asset classes come in worse than this one — last September.
Blame it on stronger-than-expected economic data that forced traders of all stripes to back away from expectations that major central banks around the globe are close to finished with monetary tightening. Amid a growing realization that policy makers are likely to stay hawkish for the coming months, investors dumped almost every financial asset, seeking safety in cash.
“The ‘higher for longer’ reality is catching up,” said Lindsay Rosner, multi-sector portfolio manager at PGIM Fixed Income. Recent US inflation data “threw water on the ‘feel good’ rally and that is why the straight line higher in total return, tighter in spreads, has started to unwind.”
This marked an about-face from January, when investors binged on risky assets, bidding up everything from unprofitable tech stocks to Bitcoin. All-or-nothing stakes have been a constant feature of the post-pandemic market, where almost every asset is so hinged to the trajectory of economic news and central bank policy that together they effectively become one big macro trade.
Tuesday’s hot inflation print from France and Spain prompted traders to boost wagers on the peak for European Central Bank interest rates to 4% for the first time. Meanwhile, the derivatives market is pricing US rates to top at 5.4% this year, compared with about 5% just a month ago. Bond investors no longer view the odds of a Federal Reserve rate cut this year as a near-certain bet. Now it’s a coin toss.
The shift in policy expectations hit the fixed income market, with two-year Treasury yields jumping to the highest level since 2007. While stronger data, particularly in the US labor market, eased concern about an imminent recession, that risk still lingers, at least among bond traders. The yield curve between two-year and 10-year Treasuries, a widely watched indicator for potential economic downturns, this month inverted to levels not seen in four decades.
“Price action in February appears to be driven primarily by the move in short-end rate expectations in the US,” said Zachary Hill, head of portfolio management at Horizon Investments. “Better growth prospects are not a good reason to run for the exits, but in the context of how we started the year, with optimism around a Fed pivot and a low-quality rally that challenged defensive positioning, the pullback we have seen this month seems healthy to us.”
Even commodities, often touted as a hedge for inflation, couldn’t escape the pull from higher rates. Oil prices slipped for an eighth month in nine, while gold suffered its worst performance since June 2021.
After initially resisting the rate pressure, stock bulls are finally taking notice. The S&P 500 fell for three straight weeks, with February’s decline wiping out almost half of the previous month’s advance.
“What January gave, February has been taking away,” Victoria Greene, founding partner and chief investment officer at G Squared Private Wealth, wrote in a note. “Earnings season is ending, so we will be more driven by economic data in the coming weeks. And if its anything like the data we got this week, it’s not going to be fun.”
–With assistance from Eva Szalay.
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