Hawkish turn

The S&P 500 closed the week at 3,674.84, -5.79% lower. The Dow Jones closed at 29,888.78, -4.79%, with the Nasdaq lower by -4.78%. The volatility index VIX closed the week at 31.13 up from 27.75. The Euro Stoxx 600 slipped -4.60%.

The 10-year UST closed at 3.23% up from 3.16% a week before. The yield curve flattened with the yield spread between the 3-month and 10-year UST at +159bps. US Corporate Bond spreads: Investment Grade widened 37bps at 187bps and High Yield widened 90bps at 563bps. German 10-year Bunds yield closed at +1.66% up from +1.52% a week before. In Europe, Corporate Investment Grade spreads widened 34bps at 214bps and High Yield spreads widened 81bps at 583bps.

The US Dollar Index (DXY) appreciated +0.53% last week and closed at 104.70. The Euro closed at 1.0499 (-0.19% weekly); the Yen depreciated -0.45%, closing at 135.02 and the Swiss Franc appreciated +1.83%, closing at 0.9699. Gold closed at $1,839.39 depreciating -1.72%. Oil was down, Brent closed at $113.12 (-7.29%) and WTI at $109.56 (-9.21%).

^{75bps hike
The Federal Open Market Committee raised the fed funds target rate by 0.75% (the biggest increase since 1994, when Alan Greenspan led the Fed). Chairman Powell said the sudden upgrade to 75bps instead of 50bps telegraphed was due to the upside surprise in May's CPI inflation as well as escalating inflation expectations in the preliminary Michigan consumer sentiment survey (long-term expectations up to 3.3% from 3.0% prior). Powell hinted that the next move at the July meeting would be either +50bps or +75bps, pointing to more flexibility post summer. He highlighted the Committee broadly views "3.0-3.5%" as the landing zone for rates by year's end (dot plot median is 3.4%). There was no change to Quantitative Tightening (the shrinkage of the balance sheet announced via passive shrinkage + cap at $95bn/month). Powell said he is not seeking to induce recession, despite the rising unemployment rate forecasts (at 3.9% by 2023, up from 3.5% previously) as well as the cuts to GDP (end-2022 cut to 1.7% from 2.8%; end-2023 cut to 1.7% from 2.2%) still raised some questions.}

^{ECB surprise meeting
The ECB held an emergency meeting to address market volatility and the divergent moves in the bond markets which sent Italian rates surging. Two main decisions stemmed out: 1) It triggered the flexible PEPP (Pandemic emergency purchase program reinvestments), 2) internal ECB committees were tasked with “accelerating the completion” of a new anti-fragmentation tool. This tool is seen as clearing the pathway for policy rate lift off and an accelerated tightening cycle. The EBC said “the pandemic has left lasting vulnerabilities in the euro-area economy which are indeed contributing to the uneven transmission of the normalization of our monetary policy across jurisdictions”.}

^{Other central banks
The Bank of England raised interest rates for a fifth straight meeting and sent its strongest signal yet that it’s prepared to unleash larger moves if needed to tame inflation. The bank raised its forecast for the peak of inflation this year to “slightly above” 11%, reflecting the planned increase in the energy price cap in October, and said it now expects the economy to contract in the current quarter. Officials are also concerned about an economic slowdown that is putting the UK at risk of recession. The Swiss National Bank raised its policy interest rate for the first time in 15 years in a surprise move on Thursday and said it was ready to hike further. The central bank increased its policy rate to -0.25% from the -0.75% level it has deployed since 2015. Nearly all the economists polled by Reuters had expected the SNB to keep rates steady. The SNB expects inflation in Q1 2025 to reach 2.1%, outside its target for a rate of 0%-2%. In 2022 it expects a rate of 2.8%. Hong Kong raised its benchmark interest rate in line with the Federal Reserve’s hawkish move given the HKD peg with the dollar, increasing its base rate by 75bps to 2%. The government recently downgraded its annual economic growth forecast to a range of 1-2%.}

^{And Japan
The central bank kept its policy settings for yield curve control and asset purchases, in line with the forecasts of almost all surveyed economists. The yen slumped to a 24-year low last week, before recovering, while benchmark 10-year yields breached the 0.25% ceiling of the BOJ’s target range. Japanese authorities have expressed increasing concern with the currency’s weakness, with Kuroda reversing his insistence that it was generally a good thing by saying the recent slide was bad for the economy. Foreign funds have led the charge in betting against both the currency and the BOJ’s capacity to maintain yield-curve control.}

Rates
Sovereign bond yields rose strongly last week in the wake of central banks’ hawkish surprises. The US 10-year Treasury yield rose over the week, settling down at 3.23% after peaking at 3.48%. Even though market participants now expect the Fed fund rate to reach 4% next year, increasing risks of an economic slowdown have probably capped the rise in long-term yields. Regarding Europe’s sovereign bond yields they have continued their ascent with the 10-year German Bund yield reaching 1.76% and its Swiss equivalent 1.46%, both up over the week. Market participants are shifting their expected policy rate path strongly upward, seeing the euro deposit rate move up from -0.5% to 2.4% by end-2022. Periphery sovereign bond spreads have tightened strongly in the wake of the ECB’s ad-hoc meeting, as they have announced that they are working on a new anti-fragmentation tool. After peaking at 240bps the 10-year Italian sovereign bond spread vs. the Bund came sharply down to 205bps. It is likely to tighten further until market participants have more clarity on the new tool. Looking at developed credit markets, spreads have sold off in the wake of equities, with US and euro HY spreads widening. This spread widening coupled with the rise in rates has pushed the yield of both US and euro HY indices to new highs, at 8.6% and 6.8%, respectively. The activity on the HY primary market remains lackluster which does not bode well for the most-leveraged issuers.