Stocks finished higher last week, opening the month of March on a high note. The S&P 500 Index broke a three-week losing streak, rising +1.9% and ending back above the 4,000 level. The NASDAQ Composite jumped +2.6% on the week, while the Dow Jones Industrials Average rose +1.8%. Materials (+4.0%), Communication Services (+3.3%), and Industrials (+3.3%) outperformed.
Notably, U.S. Treasury prices were mostly weaker, with the 2-year Treasury yield moving as high as 4.97% on Thursday before finishing the week at 4.86%. The pullback in yields on Friday helped stocks rally and finish the week higher. The 10-year Treasury yield ended the week at 3.96%. However, the 10-year and 30-year yields spent some of last week above 4.0%, which could act as a key psychological level over the coming weeks. With the jump in risk-free yields, rate-sensitive stock sectors came under pressure, with Utilities (down 0.7%) and Consumer Staples (down 0.4%) the S&P 500 laggards on the week. Outside of stocks and bonds, the U.S. Dollar Index lost ground against the major currencies, falling 0.5% last week following four straight weeks of gains. And after two consecutive weeks of losses, West Texas Intermediate (WTI) oil rose +4.4% to $79.77 per barrel. Gold finished at $1,860.80 per ounce, rising +2.1% on the week and snapping a four-week losing streak.
Mixed Messages on Future Rate Increases Could Keep Volatility Elevated
On the macroeconomic front, Fed speak from Atlanta Federal Reserve President Raphael Bostic (nonvoter) saying he favors a 25-basis point fed funds rate hike in March helped to ease some investor fears of an outsized rate hike this month. Nevertheless, Mr. Bostic said he is also open to a higher terminal rate than his current outlook of 5.0% to 5.25%. That said, Federal Reserve Governor Christopher Waller noted last week that if inflation data remains “hot,” the policy rate will have to move higher than the current forecast. We believe mixed messages on forward rate policy could keep stock volatility elevated headed into this month’s FOMC policy meeting and before the Fed’s quiet period.
Regarding economic data, ISM manufacturing activity in the U.S. remained in contraction last month, coming in a tick weaker than expected. However, February ISM services activity remained firmly in expansion, with data components showing new orders up and prices paid moving lower. While strong sales activity, easing cost pressures, and improvements in delivery times can be viewed economically as positive, the upside surprise for the services data adds to a string of hotter-than-expected economic activity. As such, the Fed may keep pressing rates higher through the spring.
China Rebounds Post Zero-Covid; Eurozone Core Inflation Rises
Overseas, China’s rebound post zero-COVID has been stronger than top leaders in the communist party anticipated. For example, official manufacturing PMI for February saw its largest improvement in over a decade, while the top 100 developers in China saw an increase in sales for the first time in 20 months. In addition, China’s annual parliament session opened on Sunday. At the meeting, the National People’s Congress announced its 2023 growth target for China’s economy. Despite stronger reopening trends over recent weeks and months, officials set China’s 2023 GDP target at around +5.0%, in line with the +4.5% to +5.5% range government advisors recommended in November. 
In Europe, Eurozone core inflation rose +5.6% year-over-year in February, as both core goods and core services reached new record highs. Headline CPI (including food and energy) rose +8.5% year-over-year, a tick lower than January’s +8.6% rate but three-tenths of a percentage point higher than forecast. Eurozone unemployment remained steady at 6.7% last month. The still hot inflation environment could lead the European Central Bank (ECB) to keep tightening rates aggressively. Short-term interest rate futures last week pegged the ECB’s deposit rate topping out at 4%, or the highest level in the euro’s 24-year history, per FactSet.
Stocks Fall in February; Investors Closely Monitoring the Fed and Employment Situation
Back here at home, after stocks raced off to their strongest start since 2019 in January, the S&P 500 Index ended February lower by over 2.5%. Declines in February were sharper across the Dow Jones Industrials Average (down 4.2%) but more modest across the tech-heavy NASDAQ Composite, which ended February lower by 1.1%. Notably, after hitting 4,200 on February 2, the S&P 500 spent most of last month moving lower as bond yields climbed, inflation data came in hotter-than-expected, and markets adjusted to the idea that the fed funds rate is likely moving higher for longer. That said, the Index remains higher by nearly +16.0% from its October 2022 low, despite market expectations taking the Fed’s terminal rate up to 5.4% last month and basically cutting out any chance for a rate cut in 2023. Behind the scenes, earnings estimates for the first quarter darkened, with analysts now expecting S&P 500 earnings per share (EPS) to decline in both the first and second quarters of this year. Bottom line: The path of least resistance for stocks last month was lower, with the bearish narrative firmly in control of momentum as the calendar turns to March. Yet the S&P 500 has produced an average price gain of +1.0% for March over the last twenty years.
But with investors so intently focused on inflation and rates at the moment, we believe the end of the month could see increased volatility for stocks, particularly heading into the March 22nd FOMC policy decision. The February nonfarm payrolls report on Friday, followed by February CPI on March 14, and February PPI and retail sales reports on March 15, are big-rock reports that could heavily influence forward Federal Reserve policy. We expect Federal Reserve officials to respond this month if employment trends remain robust and inflation data shows continued evidence of stickiness at elevated levels. This may include reversing the slowdown in rate hikes seen over the last few meetings and deciding to lift rates by 50 basis points instead of the 25 basis points most expect. And/or policymakers could adjust their forecasts for inflation higher while adjusting lower expectations for growth in the updated Summary of Economic Projections.
Importantly, investors will closely watch where officials target their fed funds terminal rate in the updated dot plot and specifically how long most officials see higher rates lingering into 2024. In our view, it may be less about how we get to a higher terminal rate from meeting to meeting and more about the end destination. Here, we see inflation/rate risks skewed to the upside, meaning Fed officials could signal to the market a higher terminal rate with that rate remaining higher for longer than is discounted in the market today. We suspect stocks could move through another adjustment period following such a scenario, where prices move lower as investors continue to search for a baseline fed funds level that would satisfy the merits for a pause. Of course, February data on inflation and employment could show signs of cooling. This may prompt officials (and more specifically, Fed Chair Jerome Powell) to continue messaging “as is,” which would likely appease investors and potentially send stock prices higher this month. But with so much uncertainty and mixed signals across various economic indicators, investors should prepare themselves for more stock volatility ahead. And with the earnings season essentially over, macro data, the direction of interest rates, and Fed machinations will likely be key drivers for stock prices over the coming weeks.
This week, Federal Reserve Chair Jerome Powell will deliver his congressional testimony to the Senate Banking Committee on Tuesday and House Financial Services Committee on Wednesday. Look for Congress to question Mr. Powell on the state of the economy, the impact of rate policy on inflation and growth, as well as try to coax the Chair into foreshadowing his outlook for policy. But Friday’s February nonfarm payrolls report will be the key economic feature of the week. FactSet estimates forecast February jobs to grow by roughly +207,000, slowing from the upside surprise of +517,000 in January. The unemployment rate is expected to remain unchanged at 3.4% in February, holding at a multi-decade low. Wednesday’s January Job Openings and Labor Turnover Survey (JOLTS) could also receive some outsized attention heading into Friday's jobs report. Finally, with the fourth quarter earnings season essentially over, only four S&P 500 companies report results during the week.

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Alison Mueller

Email: alison.mueller@ampf.com
Phone: 612-678-7183