INFLATION EXPECTATIONS CONTINUE TO DRIVE MARKETS AS INVESTORS ASSUME STRONG FED RESPONSE

INFLATION EXPECTATIONS CONTINUE TO DRIVE MARKETS AS INVESTORS ASSUME STRONG FED RESPONSE

This week was another tough one as stocks continued to sell-off. The reason is the same as last week; inflation keeps going up, so expectations of how aggressively central banks will hike interest rates keep rising. Those expectation are now extremely high. In the US, the epicentre of this particular problem, forecasts of rate rises top 1% for 2022, with some even expecting a 0.5% rise as early as January. It is possible that inflation is so deeply embedded that a wrecking ball of that magnitude is needed to knock it down again, but far from certain.

However, there are still strong signs that much of the inflationary pressure is due to the emergence from the pandemic. In that case the central bank’s wrecking ball will smash a hole in the economy and put recovery into reverse. Typically, as risk managers we prepare for both outcomes. But with the difference in the two outcomes so vast, the middle ground is in danger of becoming no-man’s land. In reality we expect the market to walk back from these extremes; inflation won’t be as high as feared, and the impact of rate hikes less severe. Until then it will be a bumpy ride.

GLOBAL: EXPECTATIONS OF US FED ACTION IS DRIVING MARKETS

Concerns about rising US interest rates have put more pressure on equities. US Treasury yields have also continued to rise, although increases were more restrained than recent weeks. Many investors are now predicting four interest rate rises over 2022 and expectations of a 0.5% rate rise next week have risen. This has caused a further sell-off in US equities with highly valued growth stocks and smaller companies most affected. Shares in several previously strong performers, including Goldman Sachs and Netflix, tumbled after issuing slightly disappointing earnings updates.

The US Fed has been talking about its determination to tackle inflation and its messaging has been taken on board by markets. Expectations of rate rises in the UK have also increased, although rising inflation has been balanced by disappointing retail sales. In contrast, policy makers at the European Central Bank and Bank of Japan have been reassuring markets that stimulus will remain in place with the BoJ governor saying “raising rates is unthinkable”.

COMMODITIES: OIL RISING SHARPLY OVER CONCERNS OF LAGGING SUPPLY

Oil prices have continued to rise strongly this week, as international benchmark Brent Crude hit $89 a barrel. This is a steep rise from the price of $68 in early- December 2021 and is the highest level seen since 2014. The main factor is the rise in demand as fears of the Omicron variant of coronavirus continue to fade, and suppliers have so far failed to meet the increase in demand. Opec and its allies have stuck to plans to increase supplies gradually by raising output by only 400,000 barrels per day. The ongoing geopolitical tensions in Kazakhstan have also affected supply.

Companies such as BP, Shell and John Wood Group have all seen their stock prices rise as the price of oil increased. BP and Shell’s shares are up around 32% over 12 months and oil services company John Wood Group is up 23% this month. Although equities of these companies have recovered significantly as a result of the rally, they still remain below pre- pandemic levels.

CHINA: CENTRAL BANK CUTS RATES AS GDP GROWTH SLOWS

A sharp slowdown in China’s GDP growth has helped push the People’s Bank of China to cut interest rates to help stimulate the economy. China’s economy is growing at its slowest pace in 18 months as the country deals with a number of headwinds including a rolling programme of strict Covid lockdowns, a sharp slowdown in its property market and lower consumer spending. Annual GDP growth in Q4 2021 was 4%, down from 6.5% in 2020. The central bank cut its main interest rate for the first time in two years and followed this with a reduction in the main consumer mortgage rates.

Further stimulus could be on the way as the PBoC deputy governor promised to open the “monetary policy toolbox” to stabilise growth. President Xi Jinping also tried to reassure foreign investors over concerns about further government interference in his speech to the World Economic Forum, and warned about the global effects of major economies performing a U-turn on monetary policy if central banks are too aggressive tackling inflation.