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Investors ignore inflation, shrug at Fed’s rate hike and overlook Ukraine war

In the face of the big-three concerns — inflation, the Ukraine war and increased interest rates — Wall Street rallied to overcome weeks of down markets.

MANHATTAN (CN) — Inflation has not abated, the Federal Reserve finally raised interest rates, and Russia’s invasion of Ukraine persists at a terrible human cost. And yet Wall Street rallied midweek and ended Friday on an extremely high note.

By the closing bell, the Dow Jones Industrial Average gained 1,805 points for the week, while the S&P 500 and Nasdaq also pulled down big wins, nabbing 260 points and 1,050 points, respectively. The S&P 500’s gains were one of the best weekly outings for the index since late 2020.

Wall Street tries to remain days if not weeks ahead of announcements, and investors already have largely discounted inflation as well as the Fed’s interest rate hike. Instead, investors have focused primarily on kernels of good economic news over the past few days.

One of those kernels has been the price of oil. On the West Texas Intermediate exchange, barrels of crude oil dropped from about $110 to $93 earlier in the week. With Russia-Ukraine peace talks sputtering, barrels again rose above $100 a barrel but did not increase to their previous highs.

“Inflation will peak soon and there are plenty of signs pointing to a global economic slowdown regardless,” James Vogt at Tower Bridge Advisors wrote in an investor’s note Friday morning, noting that supply-chain backlogs are decreasing, oil prices have pulled back 20% over the last three days, and manufacturing indexes are dropping.

Other analysts say the Russian invasion of Ukraine have had a notable impacts on earnings, and warn about complacence. “While we expect the hit to U.S. economic output from the war to be trivial, we think that lower global economic growth and higher domestic inflation will hurt listed firms’ export earnings and profit margins,” wrote Franziska Palmas, markets economist at Capital Economics. She added that U.S. equities will see the biggest impact among technology stocks.

A team of analysts at Goldman Sachs also noted that the markets seemed to have shown “a significant relaxation” about the Ukraine invasion. “While many assets could shift further to our upside case, they are now more vulnerable if progress toward a resolution proves fleeting or if energy supplies are disrupted more severely,” analysts Dominic Wilson and Vickie Chang wrote in an investor’s note.

Certain states may feel the economic impact of the war in Ukraine differently, according to the Federal Reserve Bank of St. Louis. Trade restrictions, for example, are more likely to make an impact in the several states flagged as top exporters to Ukraine, according to an analysis from the St. Louis Fed. The analysis suggests California, New York, Pennsylvania and Illinois could bear that weight more significantly.

The big news of the week was that the Federal Reserve finally decided to increase the overnight federal funds interest rate to 0.25% to 0.5%. While the news traditionally would be bad for markets — when interest rates rise, stocks tend to fall, and vice versa — markets have planned for several rate hikes in 2022 and the news came as no surprise.

Vogt added that the Fed’s meeting “came and went without any real fireworks,” and noted that Fed Chair Jerome Powell has lead a clear path for months for investors on what the central bank was planning regarding interest rates, as well as the $9 trillion of Treasuries and other assets on its balance sheet.

“Realistically, the market has already done the Fed’s job for them,” Vogt wrote, pointing to the 2% spike in two-year Treasuries. “None of us borrow at the Fed window. We pay real market rates. In that sense, tightened monetary conditions are already here.”

Other positive data points were there for the picking this week. The Federal Reserve Bank of Philadelphia’s manufacturing business outlook survey released earlier this week hit 27.4, an 11-point increase and well beyond the 14 points many had predicted.

The job market continues to be strong, the survey found, with the employment index increasing to its highest reading ever at 38.9. Price increases also climbed to its highest reading since mid-1979, hitting 81 points.

But inflation and supply-chain issues still plague smaller companies, particularly in the leisure and retail spaces.

According to a survey by the National Federation of Independent Business, 73% of small business owners have increased their average selling prices due to the ongoing supply chain problems or staffing shortages. Perhaps more distressingly, of those who raised their prices, 44% increased prices by 10% or more, the survey found.

“The small business recovery continues to be held back due to soaring inflation, ongoing supply chain disruptions, and staffing shortages,” said Holly Wade, executive director of the group’s research center. “Most small business owners have raised their prices to adjust to the numerous challenges they are facing.”

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