After showing strength for the first few days of January, the US equity market reversed direction, falling sharply for the next several weeks. In January, a soft employment report (subsequently revised higher), an elevated inflation figure, and a stalled effort in Congress to enact a public investment measure combined to sow doubt about the near-term prospects for the US economy. The immediate worry is that persistent inflation may force the Federal Reserve to tighten monetary policy just as the economic recovery from the most severe of the pandemic-related shutdowns may be losing steam. Corporate earnings and subsequent employment figures were generally favorable, but recent increases in prices, both of basic commodities and of consumer goods, reinforced worries of stubborn inflation, requiring an energetic monetary response. Meanwhile, just as the recent surge of Covid-19 infections was abating, Russian President Vladimir Putin gave increasingly menacing voice to his revanchism, adding geopolitical tension to the mix of market worries. When Russian forces finally did invade Ukraine, however, the market rebounded rather sharply, and when the Federal Open Market Committee announced its first increase to the Federal Funds rate since before the pandemic, markets took the matter in stride. Still, the S&P 500 index fell by ¬–4.60% for the full quarter. The Mid-cap 400 index returned –4.88%, and the Small-cap 600 –5.62%. [Index returns: Standard and Poors]

Global markets performed similarly to those in the US, as the MSCI EAFE international equity index returned –3.73% in local currencies. Tightening US monetary policy and the war in Ukraine boosted the US dollar. It rose to 121.44 yen, from 115.17 at the end of December. It also strengthened to $1.1093 against the euro and $1.3152 against the pound Sterling, from levels of $1.1318 and $1.3500, respectively on December 31. EAFE returned –5.91% in US dollars. [Index returns: MSCI; currency rates: Federal Reserve H.10 release]

Expectations of aggressive movements by the Fed led to an unusually sharp rise in interest rates, especially at shorter maturities. The yield on the two-year Treasury ended the quarter at 2.28%, up from just 0.73% at the end of December. The ten-year yield ended at 2.32%, up from 1.52% three months earlier. The Bloomberg Barclays US Aggregate Bond index returned a startling –5.93% for the quarter. [Index returns: Bloomberg; bond yields: US Treasury]

The US equity market continued its recent uncomfortable pattern of volatility around a generally downward trend during February. Economic indicators, particularly regarding employment, were generally favorable, but many market participants have become increasingly concerned that recent increases in prices, both of basic commodities and of consumer goods, may yield to a pattern of stubborn inflation, requiring an energetic monetary response. Meanwhile, just as the recent surge of Covid-19 infections was abating, Russian President Vladimir Putin gave increasingly menacing voice to his revanchism, adding geopolitical tension to the mix of market worries. When Russian forces finally did invade Ukraine, however, the market rebounded rather sharply. Even so, for the full month the S&P 500 index returned -2.99%, with particularly severe losses among the largest growth stocks. The Mid-cap 400 index actually advanced, adding +1.11%. The Small-cap 600 also rose, adding +1.40%. [Index returns: Standard and Poors]

International stocks were also weak; the MSCI EAFE international equity index returned -1.77% in local currencies. Currency movements were not a major factor among the developed markets, in spite of the widely-reported collapse in value of the Russian ruble. The US dollar ended February at levels of 115.11 yen, $1.1224 per euro, and $1.3419 per pound Sterling, not much different from its month-earlier levels of 115.22 yen, $1.1212/euro, and $1.3439/pound. EAFE returned -1.77% in US dollars. [Index returns: MSCI; currency rates: Federal Reserve H.10 release]

While the Russian invasion of Ukraine pushed both Covid-19 and the Federal Reserve out of the headlines, most market participants continue to expect the Fed to begin raising short-term interest rates at its upcoming March meeting. Perhaps in anticipation, interest rates rose, especially at shorter maturities, resulting in a flattening of the yield curve. The yield on the two-year US Treasury note ended February at 1.48%, up from 1.18% at the end of January. The ten-year Treasury yield ended the month at 1.83%, a slight increase from its January 31 level of 1.79%. The Bloomberg Barclays US Aggregate bond index returned -1.12% for the month. [Index returns: Bloomberg; Treasury yields: US Treasury]

The US stock market began the year seeming to show continuing strength, but just a few days in it turned sharply lower, as a soft employment report (subsequently revised higher), an elevated figure inflation figure, and a stalled effort in Congress to enact a public investment measure combined to sow doubt among some market participants about the near-term prospects for the US economy. The immediate worry is that persistent inflation may force the Federal Reserve to tighten monetary policy just as the economic recovery from the most severe of the pandemic-related shutdowns may be losing steam. As January progressed, markets continued to slide, but as listed corporations began making their earnings reports, those fears eased somewhat, and the market bounced sharply in the final few days of the month. Nevertheless, the S&P 500 index fell, returning -5.17% for the month, and smaller stocks fared still worse. The Mid-cap 400 index returned -7.21%, and the Small-cap 600 -7.27%. [Index returns: Standard and Poors]

Overseas markets also fell. The MSCI EAFE international equity index returned -3.64% in local currencies. The US dollar strengthened somewhat, largely on the prospect of less accommodative monetary policy from the Fed. The dollar ended January at 115.22 yen, up slightly from 115.17 a month earlier. It strengthened somewhat more against European currencies, ending January at levels of $1.1212 to the euro and $1.3439 to the pound Sterling, compared to levels of $1.1318 and $1.3500, respectively, at the end of December. With the currency movements, EAFE returned -4.83% in US dollars. [Index returns: MSCI; Currency rates: Federal Reserve H.10 release]

The general expectation of an upward shift in policy rates from the Fed drove market interest rates higher. The two-year US Treasury note yielded 1.18% at the end of January, up from 0.73% at the end of December. The ten-year yield rose to 1.79% at January 31, from 1.52% a month earlier. Higher interest rates correspond to lower bond prices, and the Bloomberg Barclays US Aggregate Bond index returned -2.15% for the month. [Index returns: Bloomberg; Treasury yields: US Treasury]