Stocks sinked after data showed that U.S. inflation surpassed expectations in May. The annual rate of inflation based on the consumer price index (CPI) hit a new 40-year high of 8.6%, dashing investors’ hopes for a Fed pause at the end of the year. Most of them worry that in its bid to combat inflation, the central bank will tip the economy into a recession. To make matters worse, the University of Michigan's preliminary June sentiment index fell to 50.2, from 58.4 in May. This is its lowest recorded value, comparable to the trough reached during the early 1980s recession.

The S&P 500 fell further on the news, tumbling more than 5% for the week. The benchmark index is on the cusp of a bear market (down -18.16% year-to-date). The Nasdaq composite lost nearly 673 points, dropping 5.60% week-over-week (-27.52% for the year). The blue-chip Dow Jones Industrial Average slipped 4.58%, or 1,507 points (-13.61% for the year).

European equities also ended the week on a gloomy note against the challenging backdrop of red-hot inflation and ECB’s monetary policy tightening. ECB President Christine Lagarde revealed plans to start raising its key rate in July but her response to taming inflation was deemed tepid, pushing the greenback higher (EUR-USD down 1.79%). The MSCI EMU nosedived by 4.44% (-16.21% for the year) while the FTSE slipped 2.86% bringing its year-to-date performance to -0.91%.

By contrast, the Chinese market bucked the trend with Hong Kong’s Hang Seng up 3.43% and the Shanghai Composite up 2.80% (-9.75% for the year) even though Beijing and Shanghai are locking down again, amid rising Covid-19 cases. China tech stocks rallied (e.g., Alibaba Group Holding up 17.84% for the week) as the country is reportedly easing regulatory crackdowns on its tech sector. The Chinese government has thus approved 60 new online game licenses. That said, the lockdowns could make the inflation picture worse as supply chain problems are likely to continue. The Nikkei 225 also fared well, though to a lesser extent, edging up 0.23%, thereby confirming that Japanese stocks have become an interesting contrarian play (-3.36% year-to-date).

A sea of red swamps all the S&P sectors     

Financials were the biggest drags (-6.77% over the week) on the broader market, paced by a decline in banks as stagflation worries continue to flatten the yield curve, which reduces the profit banks make from lending. Soaring bond yields hit the IT and real estate sectors (down -6.38% and -6.15% respectively). Consumer discretionary also faced heavy selling pressure (-6.07%), weighed down by Amazon stocks (down -10.38%). Once again, energy was the only sector able to weather the storm, edging down -0.92% though oil prices rose for the seventh week in a row (WTI crude oil up +1.51% at $120.67 a barrel).

Bond crash

An unexpected step-up in the pace of inflation pushed the yield of the U.S. 10-year T-note to 3.16%. It has already lost almost 14% of its value since the beginning of the year. The yield on the benchmark 2-year T-note, meanwhile, rose by 40 basis points to 3.06%. At the same time, the 5-year rate hit it highest level in more than a decade (3.26%), exceeding its 30-year counterpart (3.19%). The flattening yield curve is sending the signal that the Fed’s tightening may set off a recession. In the wake of the U.S. Treasuries, the 10-year Bund yield rose back to its highest point since March 2014 (+24 basis points at +1.52%). The spread between the 10-year German and French yields widened another 7 basis points to +58 bps.

All bond classes were severely hit by surging yields. Investment grade corporate bonds posted their biggest weekly percentage decline since March (-1.90% in Europe, -2.32% in the U.S.). That translates to a year-to-date loss of 14.66% for U.S. IG bonds. In a nutshell, the global bond market just suffered its greatest drawdown on record. 

High-yield bonds also took it on the chin (-1.33% in Europe, -1.70% in the U.S.). Emerging debt plunged 2.75%, snapping a 3-week winning streak.

Elsewhere, the yellow metal bounced back (spot price up 1.10% at $1,871.60/Oz). In the crypto space, the price of Bitcoin (BTC USD) plunged to its lowest point since December 2020, below $28,000.

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