Monthly Market Update - March 2023

February Highlights:

  • 10-year Treasury yield up 0.60% during the month, from 3.4% back to the 4% range.
  • Core personal consumption expenditures (PCE) inflation posted a surprise increase month-over-month from 4.6% to 4.7%, causing bond markets to re-price interest rates “higher for longer.”
  • S&P 500 declined 2.4%.

Evidence accumulated in February that inflation is going to be sticky, despite the Fed’s unprecedented pace of interest rate hikes. The tight labor supply appears to be a primary culprit for the Fed’s difficulties. Unemployment fell to 3.4%, the lowest rate in 53 years, while the reports for monthly core PCE inflation over the previous year edged up from 4.6% in December to 4.7% in January.

The market’s recognition of these inflation and labor challenges took the wind out of the optimism that had produced strong stock returns in the last quarter of 2022 and into January. The S&P 500® Index dipped -2.4% for the month, putting the year-to-date return at +3.7%. The same pressures caused bond yields to rebound during the month as the 10-year Treasury yield appreciated from 3.4% to end the month in the 4% range. The continued strength of consumer spending in January was another worry for those looking for interest rate relief from the Federal Reserve.

Federal Reserve Chairman Powell and his governors have been broadcasting their intent to continue raising rates and to maintain them for "some time." These statements have been seen as positioning needed to keep expectations and financial markets dampened. However, the recognition that underlying inflation may be showing stubborn persistence has convinced more investors to take the Fed at its word. One result over the past month has been a reckoning that upcoming raises in the Fed Funds Rate may be more aggressive than previously anticipated. Fed futures trading reflects an increased possibility of a 0.50% increase coming at the March meeting rather than just another 0.25% increase. At the same time, economic trends revealed this past month have diminished hope that the Fed may pivot before the end of 2023.

Another interesting development in February was the release of December’s M2 money supply data that showed the first year-over-year contraction of the money supply since 1981, indicating that the Fed’s tightening policies are finally showing signs of implementation. However, even with December’s contraction, the total M2 money supply is still up 39% compared to pre-pandemic levels.

It seems that, at least for the moment, the consensus has concluded that we can anticipate higher rates for longer. This shift will likely demand continued patience from investors as the lagging effects of rate increases slowly reverberate through the economy. Corporate earnings predictions for the remainder of the calendar year are declining, while investment grade bond yields have increased to the 5% range, marking the first time since 2008 that the yield on bonds is competing with the earnings yield on stocks.

With bond yields at their most attractive levels since pre-2008, we feature Mike Wachter, Head of the Reinhart Fixed Income Team at Madison Investments, in this month’s Q&A.

“Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC (“MAM”), and Madison Investment Advisors, LLC (“MIA”). MAM and MIA are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison’s toll-free number is 800-767-0300.

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