These Are Strange Days for the Markets

Investors who watch the markets often know what different events mean for the various asset classes. Anyone who follows financial media has heard the typical statements like inflation is good for gold and bad for growth stocks. However, some investors might not know what to think right now because the standard expectations for the market aren't holding.

Just the facts

There's no denying that the macroeconomic and geopolitical environments are complicated right now, and those complexities are sending ripples through the markets. For example, we know inflation is soaring. In the U.S., inflation was up 7.9% year over year in February, the fastest rate of price increases in 40 years.

The U.S. Dollar Index remains high at 98.68, having jumped about two points since the Russian invasion of Ukraine. The gold price is up significantly over the last 60 days, having risen above the psychological level of $1,900 an ounce. Although it is off its peak close to $2,050 an ounce, the yellow metal remains firmly above $1,900, hovering around $1,950 an ounce. The gold price is up 12% over the last six months.

The 10-year Treasury yield is holding steady at about 2.457% after surging to a new two-year high. The yield on the benchmark 10-year Treasury rose 10.4 basis points, while the yield on the 30-year rose 7.1 basis points to 2.583%.

The U.S. labor market continues to show signs of strength as initial jobless claims slipped to the lowest level in more than 50 years. New applications for unemployment benefits fell to 187,000, significantly better than the consensus of 210,000. However, U.S. orders for durable goods fell more than expected amid returning supply chain issues.

Prices for crude oil are falling amid expectations that Russian oil and natural gas will not be sanctioned anytime soon. Bitcoin is up 2% on the day as it approaches $45,000, and U.S. stocks are up, with the S&P 500 on track for its second consecutive weekly gain, and the Dow Jones Industrial Average and even the tech-heavy Nasdaq Composite and Nasdaq 100 are in the green for the week.

Typical expectations

The problem with all the above news is that it sends mixed signals about what to expect next. Inflation is usually good for gold and bad for tech stocks, but tech stocks are shaking off the concerns. A strong dollar is typically bad for gold, but both have been rallying recently.

Falling jobless claims are usually good for the stock market, so that is one trend that remains as usual. Inflation is generally good for the dollar and the Dollar Index, so that's another trend in line with typical expectations. Again, inflation usually supports Treasury yields, and we're seeing that occur right now. Investors demand higher yields when inflation is up. Bond yields are negatively correlated with prices.

The impact of sanctions

Meanwhile, heavy economic sanctions against Russia for its invasion of Ukraine are complicating matters. For example, when the first round of sanctions was announced in February, stock markets entered correction territory. However, with the latest round of sanctions, stocks rose. There isn't necessarily a standard pattern linking sanctions with stocks from countries other than the one being sanctioned.

This week, G7 countries agreed to coordinate their sanctions against Russia in what they hope will cripple its economy. More than 400 individuals and entities are now being sanctioned, so the hope is that Russian President Vladimir Putin will start to see waning support for the war against Ukraine.

In an email this week, Edward Moya of OANDA noted that the worst thing the G7 could do to Russia would be to enact an embargo on its coal, oil and gas. However, it looks like that "card won't be played until Europe has made better protections to deal with that shortfall in energy."

"The next phase of the war is circled with uncertainty as the Russians can emphasize cyber, or even worse chemical and nuclear attacks," Moya said in an email. "The Russian economy is heading towards a bad recession and that could prompt action that does not make this a long war."

Although oil prices have declined this week, they remain above the key $100 per barrel level. A major focus for crude right now is the war in Ukraine, so oil prices are likely to remain elevated. Additionally, non-OPEC producers are not keen on ramping production anytime soon as they cling tightly to their capital discipline.

Watching the Fed and weighing uncertainty

Another factor that's increasing uncertainty in the markets is the Federal Reserve. Investors are constantly watching the Fed for clues about when and how quickly it will raise interest rates and stop adding to its balance sheet.

On one hand, the U.S. economy is strong, as evidenced by the low unemployment reading, which means it should be able to withstand rising interest rates. Additionally, part of the Fed's job is controlling inflation, and since we're starting to see runaway inflation, the Fed will have to raise interest rates to bring it under control.

Wall Street is trying to determine just how aggressive the Fed will be with its tightening efforts. Investors are also trying to figure out how high oil prices will go and whether the war in Ukraine will last a few months or go on for an extended period. Due in part to all this uncertainty, the S&P 500 hit 4,500 in a sign of risk-on sentiment, but Moya believes the level to watch is 4,541, which he sees as a significant resistance level.

"Too much geopolitical uncertainty and likely commodity price stress will cap this current stock market advance," he said.

Gold and bitcoin prices

One asset to keep an eye on right now is gold. When the stock market rallied as bond yields soared, gold tumbled because both situations are bad for it. Typically, we would expect ultra-low unemployment to also take a bite out of gold, but that isn't happening.

Instead, investors are focused on the uncertainty driven by the war in Ukraine. They're waiting for the impact of the latest round of U.S. sanctions, which keep all Russian entities facing sanctions from conducting any transactions in gold. Those on that sanction list won't be able to sell any of their gold holdings.

The Fed's commentary and decisions are also impacting the gold price. An aggressive Fed would mean good things for gold because the yellow metal is widely seen as an inflation hedge and safe-haven holding.

"A big part of today's gold rally coincided with a wrath of Fed speak that suggests a much more aggressive pace of tightening policy, which will ultimately drive growth concerns by the time we get to the summer," Moya said. "For the day, gold is once again an inflation-hedge, safe-haven, and risky asset."

Bitcoin, which many see as digital gold, is also rallying as Wall Street takes up a risk-on position. Additionally, a Russian lawmaker suggested that they could accept bitcoin as payment for oil. However, that might not be a good thing for cryptocurrencies as a whole.

"Using crypto to skirt sanctions, however, is not what the cryptoverse needs for long-term growth," Moya said. "Bitcoin should still remain confined to its recent trading range until institutional traders decide to rotate out of stocks."

It's going to be very difficult to predict where many of the major asset classes will go next. A shift in risk sentiment, changes in commentary from the Fed, and signs that the war in Ukraine is winding down or getting worse will all have sizable impacts on the markets. Unfortunately, all the macroeconomic and geopolitical uncertainties mean even the experts will have difficulties predicting the directions of those impacts.

Related: Can the Fed Avoid a Recession? Why $105 Oil Could Lead To $2,000 Gold