The MSCI AC World Index logged its third straight week of gains as oil prices continued to
ease. In the United States, the S&P 500 was basically flat while the Dow Jones fell
slightly, and the NASDAQ rose 0.7%. European stocks continued to rebound - adding 1.5%. The 10-year
U.S. Treasury yield came off its recent high - slipping 9 basis-points to 2.38%.
The Federal Reserve is trying to break the cycle of rising prices without breaking the
economic cycle. This is not an easy task and has led investors to price in an
aggressive monetary policy tightening cycle. These expectations are being reflected in the bond
market with the 2s10s yield curve recently inverting. A general rule of thumb is that recessions
tend to occur sometime in the two years that follow an inversion. However, that rule of thumb
tells us very little about near-term U.S. equity market performance.
Importantly, the future is not yet written. If inflation gradually falls and the
Fed eventually shifts to a less aggressive stance, then the odds of a “soft landing” will rise.
Investors will receive more guidance from the release of the Fed’s March 16th meeting minutes,
which are likely to shed light on the Fed’s plans for balance sheet reduction.
Shawn Snyder
Head of Investment Strategy,
Citi Personal Wealth Management
Last Week's Closeof the main usa
stock market indices
S&P 5004,546
(+0.1%index up 0.1% from
last week)
DJIAdow jones industrial average34,818
(-0.1%index change down
0.1% percent from last week)
NASDAQ14,262
(+0.7%index change up 0.7%
percent from last week)
Breaking the Cycle
The Federal Reserve is trying to break the cycle of rising prices without breaking the economic
cycle. History suggests this is not an easy task with the Fed’s response to inflationary pressures
in the late 1970s and early 1980s leading to a hard landing for the U.S. economy (see figures 1 and
2). It is these worries that led to the 2-year U.S. Treasury yield rising above the 10-year U.S.
Treasury yield – also known as an inversion of the 2s10s yield curve.
Figure 1. U.S. Consumer Price Index (%) vs. Periods of U.S. Recession
(Gray Columns)
This line chart shows the U.S. Consumer Price Index percent versus the Periods of U.S. Recession from 1955 to 2022 year-to-date.
Sources: Haver Analytics and Citi U.S. Wealth Management as of February 2022.
Figure 2. Effective Federal Funds Rate (%) vs. Periods of U.S. Recession (Gray
Columns)
This line chart shows the Effective Federal Funds Rate percent versus the Periods of U.S. Recession from 1955 to 2022 year-to-date.
Sources: Haver Analytics and Citi U.S. Wealth Management as of March 2022.
The reason an inverted yield curve is a big deal is because it is often considered to be a leading
economic indicator of a potential U.S. recession. In fact, every U.S. recession in the past 60 years
has been preceded by an inverted yield curve. There was just one instance where an inverted yield
curve was not followed by a U.S. recession, in the mid-1960s, when the Fed was able to pull off one
of its soft landings. The general rule of thumb is that a U.S. recession is likely within the next
two years with a range of about six months to 24 months (see figure 3).
Of course, every time the yield curve inverts investors debate whether it is a false signal. Those in
the false signal camp argue that the Fed’s bond buying program, or quantitative easing, has pushed
down the 10-year U.S. Treasury yield and when the Fed stops buying bonds the 10-year U.S. Treasury
yield will rise and the curve will steepen. Others argue that the 2s10s curve is the wrong curve to
watch and that investors should be watching the spread between the 3-month T-bill and the 10-year
U.S. Treasury yield, which is nowhere near inversion. That’s is certainly true, but it is largely
because the spread between the 2s10s curve is reflecting what investors expect the Fed to do and the
3Mo10s curve is reflecting what the Fed has done thus far. It makes sense that they are currently
showing two different outcomes given that the Fed has just begin its monetary policy tightening
cycles. The primary takeaway from the difference between the two yield curves is not that one is
wrong and one is right, but that the future is not yet written.
Figure 3. 2s10s Yield Curve (%) vs. Periods of U.S. Recession (Gray
Columns)
This line chart shows the 2s10s Yield Curve Percent verses Periods of U.S. Recession from 1977 to 2022 year-to-date.
The 2s10s curve tends to invert about 15 months prior to the onset of recession.
Sources: Haver Analytics and Citi Global Wealth Investments as of March 2022.
Currently, the two-year U.S. Treasury yield is pricing in the equivalent of about 10 rate hikes. If
we look at the futures market, it is pricing in eight rate hikes with a 50 basis-point rate hike
likely in May and about a 62% chance of 9 rate hikes, which presumably means back-to-back 50
basis-point rate hikes in May and June (see figure 4 and 5). This is consistent with Fed Chair
Powell saying, “Nothing,” was keeping the Fed from raising rates by 50-basis-points.
Figure 4. 2-Year U.S. Treasury Yield vs. Federal Funds Rate (%)
This line chart shows the two year U.S. Treasury Yield in percent versus the Federal Funds Rate from 2012 to 2022 year-to-date.
Sources: Haver Analytics and Citi U.S. Wealth Management as of March 31, 2022.
Figure 5. Number of Fed Rate Hikes Expected by the End of 2022
This line chart shows the Number of Fed Rate Hikes Expected by the End of 2022, beginning June 2021. The market is
still pricing 8-9, equivalent to 25bps, in Rate Hikes by Year End.
Sources: Haver Analytics and Citi U.S. Wealth Management as of March 2022
Importantly, the Fed could still change its mind. If inflation gradually falls, then the Fed may
decide to slow down its tightening cycle, which would significantly raise the odds of an economic
“soft landing.” However, as it stands now, it appears to us that the Fed is intent on tightening
policy until inflation comes down sharply. Only time will tell whether the Fed will succeed in its
stated goal of, “The economy achieves a soft landing, with inflation coming down, and unemployment
holding steady.”
What Does an Inverted Curve
Mean for U.S. Stocks?
Surprisingly, very little in the near-term. During the last five U.S. recessions, the S&P 500 did not
peak until about four months prior to the onset of recession (see figure 6). The weakest lead time
was in February 2020 when policymakers engineered a recession with lockdowns in order to limit the
spread of COVID-19. However, during more traditional recessions the market peaked as far ahead as
eight months and as little as two months ahead. The primary reason this occurs is that corporate
earnings often continue to rise as the economic cycle transitions into its later stages. For
example, even in the face of a potential recession down the road, S&P 500 earnings-per-share (EPS)
are still projected to climb by 10.3% in 2022. We think this argues against exiting the equity
market altogether. We prefer a more defensive, diversified portfolio that focuses on quality
companies with strong balance sheets and stable earnings (global pharmaceutical companies, consumer
staples companies, and dividend growers). Investors may also want to consider potential inflation
hedges like natural resources, agriculture, metals, and other commodities. For detailed insights on
global fixed income markets and potential opportunities, please see our CIO Strategy Bulletin | A Brighter Future for Fixed Income?
What Should U.S. Investors
Watch in the Week Ahead?
We suspect that the release of the March 16th Federal Open Market Committee (FOMC) meeting minutes on
Wednesday at 2PM EST will garner most of investors’ attention. It is widely anticipated that the
minutes will include details on plans to bring down the Fed’s balance sheet. The minutes may also
discuss the Fed’s feelings on 50-basis-point rate hikes at upcoming meetings. Citi Research’s
economists believe that the roll off will begin with $15 billion per month of Treasuries and $10
billion per month of mortgage-backed securities. Eventually that pace will likely be scaled up to
$45 billion per month in Treasuries and $30 billion in mortgage-backed securities. There will also
be a slew of Fed speakers this week that could make headlines with Brainard, Daly, Williams, Harker,
Bullard, Bostic, and Evans each making comments.
Market
Indicators
Figure 6: U.S. Stock Market Returns and
Select Assets
Index
Weekly Chg change in percent
YTDyear to date change in percent
12 Months12
month change in percent
Div. Yield division yield in percent
Dow Jones
-0.1%
-4.2%
5.0%
1.8%
S&P 500
0.1%
-4.6%
13.1%
1.4%
NASDAQ
0.7%
-8.8%
5.8%
0.7%
Instrument
Weekly Chgchange
YTDyear to date
12 Months12
month change
Level
10-Year Treasury Yield (%)
-9 bps
87.2 bps
71 bps
2.38%
Gold ($/Oz.)
-1.7%
5.3%
11.4%
$1,925.7
Oil ($/bbl)
-14.0%
28.9%
61.5%
$99.27
❮ Swipe left for more
This table shows returns for various USA equity markets and select assets, in weekly,
year-to-date and 12 month changes.
Strong corporate earnings are bolstering the equity market.
Figure 7: International Stock Market Returns
Index
Weekly Chg change in percent
YTD year to date in percent
12 Months
Div. Yield division yield in percent
Global
0.4%
-5.6%
4.7%
1.9%
Europe
1.5%
-8.2%
0.3%
2.8%
Japan
-2.5%
-8.8%
-9.7%
2.2%
Emerging Markets
1.9%
-6.6%
-12.3%
2.5%
❮ Swipe left for more
This table shows the percent changes of stock market returns for Global, European,
Japanese and Emerging Markets, over weekly, year-to-date and 12 month periods.
Sources: Bloomberg and Citi U.S. Wealth Management as of April 1, 2022. Note 1 (Equities): Global = MSCI All Country World Index (USD); Europe = MSCI Europe (USD); Japan = MSCI Japan (USD); Emerging Markets = MSCI Emerging Markets (USD). The equity index returns shown here are based in U.S. dollars. Returns for a non-U.S.-based investor can differ significantly depending on the effects of foreign currency exchange. Note 2 (Instrument): Gold = U.S. dollars per Troy ounce; Oil = West Texas Intermediate crude at Cushing, OK. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is not indicative of future returns. Real results may vary.
The
Week Ahead
Figure 8: The Week Ahead
Date
Time
Event
Period
Consensus
Prior
4/5
10:00
ISM Services Index
MarMarch
58.5
56.5
4/6
14:00
FOMC Meeting Minutes
3/16/2022March
Sixteenth Twenty Twenty Two
--
--
4/7
8:20
Initial Jobless Claims
4/2/2022April
Second Twenty Twenty Two
200kthousand
202kthousand
This table lists a number of key economic events, analysis reports and forecasts from
influential institutions.
Sources: Bloomberg and Citi Global Wealth Investment as of April 1, 2022
Shawn Snyder
Head of Investment Strategy,
Citi Personal Wealth Management