After a strong January for the markets, February was a reality check on what we might expect for the rest of the year. Despite early gains, we saw softening last month. U.S. markets declined by low single digits, while international markets also dropped. Developed markets were down about the same as those in the U.S., and emerging markets performed worst of all. So, what happened—and where do we go from here?
The Bad News
Last month’s declines were driven by unexpectedly poor data on inflation, with the Fed committing to a hawkish stance and longer-term interest rates starting to rise again. The benchmark yield on the 10-year U.S. Treasury note rose by more than a half-point, to above 3.9 percent. With inflation projected to stay high, markets are betting on the Fed continuing or even accelerating its rate increases. Expected higher rates typically mean lower bond and stock prices, and that is just what we saw.
The Good News
But there was some good news, too. Those inflation worries were driven by better economic data. At more than half a million for the month, job growth beat expectations by almost double. Further, service sector business confidence bounced back into expansion. Retail sales and consumer spending showed strong growth, and business investment ticked up as well.
So, despite rising interest rates, this strong economic data means a recession looks even less likely in the short term. The job market remains strong, and business confidence and investment are up again. The economy looks likely to keep growing, and the economic risks are still contained. This is all good news as we head further into 2023.
Of Course, Risks Remain . . .
It is not all about the economy, of course. There are also political risks in play. Here in the U.S., the debt ceiling confrontation is moving closer. On the international scene, China remains a wild card, both for economic reasons and as it takes a more active role in the ongoing Ukraine war. Then there are the risks we don’t yet see.
Despite those risks, there are signs that things will be better six months from now than they are today. Inflation is still a factor, but the economy is stronger than expected. Interest rates are ticking back up again, but this is offset by the better economic conditions. This mix of good and bad news explains the markets last month—but it also sets the stage for how things could improve over the next several months.
A Better Place
The debt ceiling confrontation will be resolved, for example. We will know where we are with a recession. And inflation and rates should roll over once more. When things are likely to get better, the downside risks tend to be contained, which is where we are right now.
In other words, we do face real risks, but we are increasingly moving past many of them. We are certainly not done with turbulence and will likely see more of it. But despite everything? We are still in a pretty good place.