The New York Stock Exchange on Friday: Financial markets appear less fearful than they did just a week ago.
NYSE
This past week might be remembered as the one when markets tried to stop worrying and accept the war.
At first glance, it might not seem that way. The S&P 500 dropped by 2.9%, while the Dow Jones Industrial Average fell 2% and the Nasdaq Composite
lost 3.5%.
The market had plenty of reasons to fret. Russia showed no sign of wanting to end its war on Ukraine and appeared ready to escalate attacks, not halt them. In response, the U.S. said it would remove “most favored nation” trading status from the country and blocked Russian oil imports. U.S. corporations, including Goldman Sachs Group (ticker: GS), McDonald’s (MCD), and JPMorgan Chase (JPM), continued to flee.
Yet despite the losses, financial markets appear less fearful than they did just a week ago. The 10-year Treasury yield (which moves in the opposite direction of its price), rose 0.282 percentage point to 2.004%, while the Cboe Volatility Index, or VIX, closed at 30.75 on Friday after trading as high as 37.35 during the week. Even oil finished the week down 5.5%, at $109.33.
“There’s been a sense of normalcy in recent days,” says Dave Donabedian, chief investment officer at CIBC Private Wealth U.S. “What we don’t know is whether this is a countertrend trade that will flame out or if it is the beginning of stabilization.”
The junk-bond market has gotten even less worked up. While spreads between high-yield bond and Treasury yields have blown out—from around three percentage points at the end of 2021 to four points on March 10—it’s a far smaller move than suggested by the rise in the VIX, says Martin Fridson, CIO at Lehmann Livian Fridson Advisors. Based on his analysis, the gap between the yield on junk bonds and the equivalent Treasury should be 7.81 percentage points, given Thursday’s VIX of 31.06. “Given the volatility you’re seeing in the stock market, it’s usually been the case that the risk premium in high-yield bonds has been substantially greater,” Fridson says.
In the past, that discrepancy has typically resolved itself by the VIX falling further, which would typically lead to higher markets rather than a widening spread. That was the case in October 2020, when the VIX hit 38.02 but high-yield spreads were just 5.32 percentage points, and in 1997, when the VIX hit 35.09 but spreads remained at a ridiculously low 2.99 points. It’s possible that history repeats, but Fridson worries that this time could be different because of the Russia-Ukraine war.
“You don’t have a major land war in Europe as part of that [history],” he says.
The Federal Reserve might have something to say about it as well. The Federal Open Market Committee meeting ends on Wednesday, and the outcome shouldn’t be a surprise. Chairman Jerome Powell already told us that he would recommend a quarter-point rate increase, and there’s no reason to think the rest of the voting members won’t agree.
How the market reacts, then, could depend on what the Fed says about future rate hikes and its plans for quantitative tightening. If the Fed tells the market how it will run off its balance sheet, the market could sink, but if it says it has a plan to wind it down, the market might relax, CIBC’s Donabedian says.
There’s always something else to worry about.
Write to Ben Levisohn at [email protected]
