Equity and bond markets fell this week as the US Federal Reserve (Fed) continued to communicate a desire to get ahead of inflationary pressures, with further tightening of monetary policy through rate rises and a rapid withdrawal from the bond purchasing programme. This coincided with further sanctions being taken against Russia by the US and Europe, raising concerns that this could further pressure consumer prices higher. Inflation across much of the OECD rose 7.7% for the year to February, versus 1.7% in the same month last year. Whilst energy has been by far the largest contributor, with the annual rate of inflation running at 27%, there is evidence that this is increasingly trickling through to other areas, with food inflation having increased by 8.6% for the year to February.
As of 12pm on Friday, London time, US equities fell 1.0%, whilst US technology stocks dropped 2.6%. European equities, more exposed to financials which benefit from rising rates, rose 0.4%, whilst the UK market rose 0.9%. The Japanese stock market suffered a broad sell-off in tandem with US equities, losing 2.4%, whilst the Australian market fell 0.2%, shielded by the worst of the market moves through significant exposure to financials and commodities. Emerging markets dropped by 1.7%, with Latin America suffering the most as the dollar strengthened and crude oil prices fell, leading to the region recording a loss of 3.4% over the week.
Minutes released by the Fed this week from the last interest rate setting meeting showed several members believing that a half point interest increase would have been appropriate, were it not for the Russian invasion of Ukraine and the resulting economic uncertainties. Fed Governor Lael Brainard said on Tuesday that she expected the Fed to embark on a “rapid” reduction of its balance sheet from May. 10-year US Treasury yields, which move inversely to prices, rose to 2.68%, a new high for this year. German bunds increased to a yield of 0.68% and UK gilts 1.73%.
Commodities were mixed, with gold rising 0.6% to $1,936 an ounce, copper up 1.1%, trading at $10,311, whilst iron ore fell 4.2%, as did crude oil, with Brent falling 3.9% to $100.3 a barrel and US WTI (West Texas Intermediate) to $96.2.
Investors are having to weigh up the chances of a recession, triggered by tightening monetary policy and rising commodity prices versus a robust economic recovery as the world exits covid restrictions.
However, to further complicate the picture, unlike most of the rest of the world, China continues to operate a zero-tolerance covid policy, locking down entire cities to control the spread of the disease regardless of the resulting economic fallout. Expectations are therefore strongly in favour of China to increasingly ease monetary policy in the second half of this year, whilst the Fed continues to tighten, potentially offsetting some of the growth concerns.
However, right now, the Fed is tightening, China is suffering from lockdowns and Europe faces the potential for sharply higher energy prices should either Russia block the supply of oil and gas, or perhaps increasingly likely, Europe decides that it simply cannot trade with Russia in the face of seemingly worsening war crimes being reported by Ukraine on an almost daily basis.
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