U.S.

Recession worries deepen

The major indexes surrendered a portion of the previous week’s strong gains, as worries grew that the Federal Reserve’s fight against inflation would push the economy into recession. The S&P 500 Index closed out its worst first half of the year since 1970, as was widely reported, although the decline was amplified by the index reaching its all-time high on January 3. Typically defensive segments within the index, such as utilities and consumer staples, held up best, while consumer discretionary and information technology shares were particularly weak. Markets were slated to be closed on Monday, July 4, in observance of the Independence Day holiday.

Much of the week’s economic data missed consensus expectations, and some signals suggested that economic activity might even be slowing. T. Rowe Price traders noted that the selling started in earnest on Tuesday morning, when the Conference Board’s index of consumer confidence came in much lower than anticipated and a measure of manufacturing activity in the Mid-Atlantic region fell to levels not seen since the height of the pandemic.

Consumers pull back

Wednesday brought closely watched data on May personal consumption expenditures (PCE), which indicated that consumers were also pulling back. Adjusted for inflation, purchases fell 0.4% in May, the first decline in 2022, driven by a 1.6% drop in goods purchases; purchases of services rose 0.3%, but much of the increase was driven by spending on housing and health care. Inflation-adjusted disposable income, reported Thursday, fell 0.1% over the month.

The PCE data were enough to push the Atlanta Fed’s GDPNow model estimate of annualized growth in the second quarter down to -1.0%. If confirmed, this would meet one commonly accepted definition of a recession—two consecutive quarters of negative growth—given the 1.6% contraction in the first quarter. However, many economists note that a record trade deficit early in the year skewed the data.

Nevertheless, much of the week’s data suggested continued, if slowing, expansion. May durable goods orders surprised on the upside, especially when controlling for defense (0.6% versus roughly -0.5%). Gauges of current factory activity indicated continued expansion, but at the slowest pace since the summer of 2020. While anecdotal reports of scattered hiring freezes and layoffs continued to intensify, weekly jobless claims came in roughly in line with expectations at 231,000—within a narrow band of 231,000 to 232,000 where they have remained for four consecutive weeks. Claims bottomed at 181,000 for the week ended April 24.

Moderating inflation and sluggish growth push yields lower

The silver lining for investors in the PCE data was a downside surprise in inflation signals. The Fed’s preferred inflation gauge, the core (less food and energy) PCE price index came in at 4.7% for the 12 months ended in May, slightly below expectations and the lowest level since November. Along with the sluggish economic data, this appeared to help push the yield on the benchmark 10-year U.S. Treasury Note as low as 2.79% in Friday trading, its lowest level in a month. (Bond prices and yields move in opposite directions.)

T. Rowe Price traders cited recession fears as an underlying driver of the week’s rally in municipal bonds. However, the tax-advantaged market lagged U.S. Treasuries as continued fund outflows and weak demand for new issuance held back its performance.

According to our traders, a constructive start to the week in the investment-grade corporate bond market spurred primary issuance, and this uptick in supply pushed the market lower. This trend was exacerbated by mixed macroeconomic sentiment, as market participants weighed Fed Chair Jerome Powell's mid-week remarks, in which he reinforced the Fed's commitment to bringing inflation lower, against the lower-than-expected core PCE inflation reading. Ultimately, primary issuance fell short of weekly expectations, and the new deals that reached the market were met with adequate demand.

Bed Bath & Beyond earnings weigh on high yield retail sector

High yield bonds traded lower along with equities. Our traders reported that buyers adjusting positions ahead of quarter-end and sellers raising cash drove most the market’s activity. One anticipated new deal was announced before the primary market shut down ahead of the holiday weekend, while the retail segment experienced weakness after a disappointing earnings report from Bed Bath & Beyond increased negative sentiment across the sector.

Broad risk-off sentiment weighed on the performance of bank loans. Investors appear to be expecting a 75-basis-point (0.75 percentage point) rate hike at the late-July Federal Reserve meeting and then another 50-basis-point increase at the September meeting. Our traders noted that higher-rated loans held up better amid limited support for lower-quality paper. Negative flows from the asset class drove most of the loan market’s selling activity.

U.S. Stocks

^{This chart is for illustrative purposes only and does not represent the performance of any specific security. Past performance cannot guarantee future results.
Source of data: Reuters, obtained through Yahoo! Finance and Bloomberg. Closing data as of 4 p.m. ET. The Dow Jones Industrial Average, the Standard & Poor’s 500 Stock Index of blue chip stocks, the Standard & Poor’s MidCap 400 Index, and the Russell 2000 Index are unmanaged indexes representing various segments of the U.S. equity markets by market capitalization. The Nasdaq Composite is an unmanaged index representing the companies traded on the Nasdaq stock exchange and the National Market System. Frank Russell Company (Russell) is the source and owner of the Russell index data contained or reflected in these materials and all trademarks and copyrights related thereto. Russell® is a registered trademark of Russell. Russell is not responsible for the formatting or configuration of these materials or for any inaccuracy in T. Rowe Price's presentation thereof.}

Europe

Shares in Europe fell on fears that soaring inflation and rising interest rates could hit earnings and tip economies into a recession. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.40% lower, while Germany’s DAX Index pulled back 2.33%, France’s CAC 40 lost 2.34%, and Italy’s FTSE MIB dropped 3.46%. The UK’s FTSE 100 Index declined 0.56%, supported by a weaker British pound against the U.S. dollar. UK stocks tend to perform relatively well when the pound falls because many companies that are part of the index are multinationals with overseas revenues.

Core eurozone bond yields decreased. Yields increased initially amid inflation concerns and ahead of speeches by central bank officials at the European Central Bank (ECB) annual meeting, but lower-than-expected German inflation calmed fears, leading yields lower overall. Peripheral eurozone and UK government bond yields broadly tracked core markets.

ECB’s Lagarde sticks to rate path

While hawkish ECB policymakers continued to bring up the possibility of a 50-basis-point interest rate hike as early as July, ECB President Christine Lagarde reiterated guidance for an increase of 25 basis points followed by another hike in September, the size of which depending on incoming data. At the central bank’s annual conference in Portugal, she stated that the ECB needed to act “in a determined and sustained manner, incorporating our principles of gradualism and optionality” to tackle elevated inflation. She also said that a larger increase in the policy rate would be more appropriate “if the medium-term inflation outlook persists or deteriorates.”

T. Rowe Price’s European economics team believes that even if the rate hike is 50 basis points in September, moves of this size are unlikely to be maintained because growth data will continue to be weak, which would support a “gradual” tightening approach.

Euro area inflation hits new record, confidence worsens, German joblessness rises

Eurozone inflation accelerated to another record high of 8.6% in June, driven by soaring energy and food costs, according to Eurostat’s early estimate. A European Commission survey showed that economic sentiment weakened as pessimism among consumers deepened and retail confidence deteriorated.

Seasonally adjusted unemployment in Germany unexpectedly rose to 5.3% in June from 5% in May—the first increase in more than a year—after Ukrainian refugees were added to social security data for the first time, according to the Bundesbank.

Record UK balance of payments deficit, manufacturing PMI revised lower

The UK’s current account swung into a record deficit of GBP 51.7 billion in the first quarter—or 8.3% of gross domestic product (GDP)—partly due to the soaring costs of fuel imports. Excluding trade in precious metals, the deficit was 7.1% of GDP, matching a previous record in the final quarter of 2015.

Swedish central bank steps up rate increases

Sweden's central bank raised its benchmark interest rate by 50 basis points to 0.75%—the largest increase in more than 20 years—to stifle inflation.

Japan

Japan’s stock markets generated a negative return for the week, with the Nikkei 225 Index falling 2.10% and the broader TOPIX Index down 1.16%. The escalating risk of a global recession prompted by major central banks aggressively raising interest rates to combat inflation continued to pose a headwind.

Worsening sentiment among Japan’s large manufacturers and a bigger-than-expected drop in industrial production also weighed on risk appetite. Meanwhile, record temperatures and concerns about power shortages prompted the government to signal a renewed reliance on nuclear reactors. Against this backdrop, the yield on the 10-year Japanese government bond finished the week broadly unchanged at 0.23%. The yen remained near a 24-year low against the U.S. dollar—with weakness mainly attributable to the divergent monetary policies of the Bank of Japan (BoJ) and the U.S. Federal Reserve—finishing the week at the low end of the JPY 135 range.

Sentiment among large manufacturers worsens; factory output falls sharply

The Bank of Japan’s quarterly Tankan corporate survey showed that sentiment among large manufacturers deteriorated in the three months to the end of June. The worsening reflected concerns about China’s coronavirus lockdowns and prolonged supply chain constraints. On the other hand, confidence among services sector firms, which benefited from the lifting of domestic coronavirus restrictions, improved. Separate data showed that factory output fell sharply in May, with vehicle production particularly weak.

Core consumer prices in Tokyo rose 2.1% year on year in June, heightening the chances that nationwide inflation will continue to rise in the coming months. While the BoJ’s inflation expectations have risen—particularly in the short term and at a more moderate pace over the medium to long term—inflation, excluding such factors as energy, remains low compared with other G-7 nations.

Government warns of power shortages, would use nuclear reactors to supply electricity

The worst-ever heat wave recorded in Japan prompted the government to warn of power shortages, as higher temperatures have translated into increased demand for energy, primarily air conditioners. Households and businesses were asked to enter a three-month energy-saving period, with supply expected to remain tight due to issues such as aging thermal power plants. Prime Minister Fumio Kishida said that the government will use nuclear reactors to the extent possible to supply electricity, signaling that plants not used since the 2011 Fukushima nuclear disaster would be brought back online. The government shut down all nuclear plants in the wake of the disaster.

China

Chinese stocks advanced on the back of strong factory data and easing coronavirus restrictions for travelers. The broad, capitalization-weighted Shanghai Composite Index rose 1.3%, and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, gained 1.6%, Reuters reported.

On Tuesday, China halved the quarantine times for inbound travelers. Under the new policy, travelers must spend seven days in a quarantine facility then monitor their health at home for three days, down from 14 days under hotel quarantine in many parts of the country and as many as 21 days of isolation in the past. China’s President Xi Jinping said that the current pandemic strategy was “correct and effective and must be upheld unwaveringly.”

The yuan currency weakened to CNY 6.70 per U.S. dollar late Friday from CNY 6.69 last week, Reuters data showed. The 10-year Chinese government bond yield rose slightly to 2.847% from 2.816% a week ago, according to Dow Jones, as issuance increased. The sale of Chinese local government bonds for June is estimated to reach a single-month record high of CNY 1.93 trillion, reported the state-backed China Securities Journal.

In economic readings, the official manufacturing and services purchasing managers’ index (PMI) both rose above 50 in June as a drop in new omicron infections allowed the government to ease restrictions. The manufacturing PMI reached 50.2 in June, up from 49.6 in May, while the nonmanufacturing PMI rebounded to 54.7 in June from 47.8 in May. Meanwhile, the Caixin/Markit PMI survey, a private survey that focuses more on smaller firms in coastal regions, showed manufacturing activity expanded at the fastest pace in 13 months in June. Other data showed that profits at China’s industrial firms fell 6.5% in May from a year ago, better than the 8.5% drop recorded in April. The latest PMI readings suggest that supply chain distortions have been reduced, according to T. Rowe Price analysts, though weakness in PMI readings for steel and construction suggested ongoing pressures from China’s housing downturn.

The People’s Bank of China (PBOC) said it would employ structural policy tools to boost confidence in the economy following the central bank’s quarterly monetary policy committee meeting. T. Rowe Price analysts believe that the PBOC’s latest guidance was dovish and that stabilizing employment and prices remains a priority for the central bank.

Other Key Markets

Hungary

Investors in Hungarian assets were shocked by the central bank’s decision on Tuesday to raise its key interest rate by 185 basis points, which was much more than expected, to 7.75%. On Thursday, the central bank lifted its one-week deposit rate by 50 basis points, also to 7.75%.

According to T. Rowe Price credit analyst Ivan Morozov, protracted weakness in the forint currency and elevated inflation are the main factors that prompted the central bank to act. With core inflation recently measured at a year-over-year rate of 12.2%, and with the central bank now projecting 13% to 14% inflation for all of 2022, Morozov believes that policymakers are unlikely to pause their rate increases until inflation peaks and the forint stabilizes.

Colombia

Investors appeared encouraged by President-elect Gustavo Petro’s announcement on Thursday morning via social media that Jose Antonio Ocampo will become Colombia's next finance minister. According to T. Rowe Price emerging markets sovereign analyst Aaron Gifford, Ocampo is a technocratic choice for the position, and his presence could assuage concerns about the new administration’s pursuit of tax reform as one of its first orders of business.

Ocampo holds a bachelor's degree in economics from the University of Notre Dame and a Ph.D. in economics from Yale. He is also a former finance minister, director of national planning, and central bank board member and has held a key role in the United Nations. In addition, he is currently a professor in international and public affairs at Columbia University and has published several books and scholarly articles.

In monetary policy news, the central bank raised its key lending rate by 150 basis points, to 7.5%, on Thursday. The decision was unanimous among policymakers and generally in line with expectations; the increase was larger than the 100-basis-point rate hike at the previous policy meeting. Gifford believes that the post-meeting statement from policymakers was hawkish, with mentions of increasing inflation expectations that are now "significantly" above target over the policy horizon and economic activity that has surprised to the upside based on strong consumer demand. The central bank upgraded its 2022 GDP growth forecast to 6.3% from 5.0% previously.