Mid-Month Market Update: March 2023

Technical Trends

US large cap stocks erased their hot start to the year, declining more than 5% over the past month. The S&P 500 Index has dropped back below a falling 200-day average. The Dow Jones Industrial Average is down just 2.4% over the last year, but it’s been the laggard so far in 2023. The NASDAQ Composite, meanwhile, has been the best performing major index over the last month and quarter.

Bond prices continue have risen dramatically over the past week, after turbulence in the banking sector spooked investors. Still, the 10-Year Treasury note remains below a falling 200-day moving average – clear evidence that a downtrend still exists. While yields are down from their October peak, the threat of continued policy tightening by the Federal Reserve remains a risk for fixed income investors.

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Inflation Matters to Mr. Market

Whether we like it or not, economic data matters to the markets. Not every report will move prices, but each one has its place in building the macroeconomic puzzle. This week’s inflation update could be particularly important. Equity prices for the last year have mirrored changes in interest rates and foreign exchange rates. Rates and currencies are being impacted by central bank policy. And central banks are being forced to act in response to high inflation. Let’s break it all down.

Those who’ve followed this blog know that interest rates and currencies were the big drivers of equity price action in 2022. Check out how closely the three moved together:

Those relationships seem natural – a stronger dollar negatively impacts corporate earnings, and higher interest rates increase the cost of capital and decrease the present value of future cash flows. Still, the correlations typically aren’t that strong. Last year was nearly unprecedented.

So if interest rates and currencies are what’s driving the stock market, what’s driving interest rates and currencies? The most obvious answer is central bank policy. The US Federal Reserve began using forward guidance to tighten financial conditions in the summer of 2021, and then began hiking short-term rates last March.

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