A writer from 19th century France once noted that the more things change, the more they stay the same. This phrase could well apply to the market dynamics of the third quarter of 2022. Extreme volatility, a strengthening U.S. dollar, negative equity returns, and rising bond yields, all present throughout 2022, continued to saturate the investment landscape. During the month of July, markets pivoted to risk-on following the 75 basis points FOMC hike. Markets again reversed course in August and September after Jackson Hole and September FOMC commentary revealed a Fed determined to take forceful steps to moderate demand and return inflation toward the 2% objective. As of September 30, the S&P 500 Index was down nearly 24% year-to-date, investment grade corporate bonds down 18.72%, and 10-year bond yields were up approximately 60 bps to 3.80%.
The tug of war between FOMC messaging and the market’s interpretation was evident throughout the quarter. Despite a global economic environment plagued by the broad inflation driven up by exogenous factors such as labor shortages, supply constraints due to Covid shutdowns, and persistently high food and energy costs linked to the Russia-Ukraine war, markets interpreted Jay Powell’s July commentary as an indicator of a dovish pivot. That is, the Federal Reserve would not risk a U.S. recession in its efforts to combat inflation. However, Powell pushed back on the easing financial conditions experienced in July by delivering two hawkish messages in August and September. With U.S. labor markets remaining extremely tight, as revealed by the July employment report and a greater than expected CPI print in August, the FOMC pushed back on the market with a “higher for longer” interest rate narrative. In the Fed’s mind, aggressively attacking the inflation beast now, while the economy is strong, is the best course of action. Not only does the Fed want the market to see that the 2% inflation objective is job one, but also to appreciate it requires restrictive policy for an extended time.