Markets started the new year with strong returns across nearly all equity and fixed income asset classes, a welcome reversal following the losses most investors experienced in 2022. January’s rally was largely driven by the hope that a Fed pivot or pause was on the horizon, as a number of key economic data points indicated that U.S. inflation was continuing to cool.  

2022 ended as one of the worst calendar years on record for investors, with U.S. large cap stocks declining by just over -18% and investment grade bonds sliding by -13%. While equity market declines weren’t necessarily an outlier, bonds were another story. The -13.01% loss for the benchmark Bloomberg Aggregate Bond index was by far its worst annual decline in its history, dating back to 1976, equating to a near 3 standard deviation event.  

Cooling inflation and optimism over the future path of interest rates led markets higher across the globe in November. The benchmark S&P 500 gained 5.59% on the month, while the Bloomberg Aggregate Bond index advanced by 3.68%, as interest rates fell across most of the yield curve. International markets were an even larger beneficiary of November’s rally, with the MSCI EAFE gaining 11.26% and the MSCI EM index moving nearly 15% higher, both buoyed by a sharp decline in the U.S. dollar. 

Equity

The hope of a Fed pivot, which drove markets higher in July, faded in the latter half of Q3 as the Fed made it clear that they would continue with their aggressive rate hiking campaign until inflation is brought down to a reasonable level. During the quarter, investors saw the Fed hike rates 150 bps, in addition to increasing their interest rate expectations for 2023 by nearly 100 bps (3.75% as of June vs. 4.625% as of September). The result was a rise of 132 bps in the yield of the 2-year treasury, while the yield on the 10-year soared by 81 bps.

August’s sell off was largely influenced by Chairman Jerome Powell’s comments at the Fed’s Jackson Hole Symposium on August 26th. While he mentioned that the Fed’s future policy decisions would be data dependent, his overall tone was generally hawkish. Most concerning to markets was the Chairman’s stated commitment to taming inflation via higher-for-longer interest rates and his warning around the subsequent “pain” this could create for households and businesses.