5 April 2022
See-saw of signals
Once again, financial markets battled with ambiguity last week due to persistent military conflict in Ukraine, while the likelihood of rising interest rates and inflation continued to trouble investors.
At the beginning of the week, Russia was allegedly open to the idea of Ukraine joining the European Union, on the understanding that Ukraine pledge not to join NATO. This apparent development meant a strong start to the week for the leading US equity indices – by Tuesday, they had managed to recuperate the losses they had suffered since the invasion began in February.
Wednesday and Thursday saw a U-turn on this, however, as peace talks made no headway and Russia ramped up its efforts to take possession of the eastern Donbas region. On the whole, there was little change in US equities over the course of the week, with the S&P500 likewise looking flat.
In the meantime, hostilities rose between Russia and Europe, with President Putin demanding that “unfriendly” foreign purchasers must pay for Russian gas in roubles. Countries required to pay in roubles include those who have imposed sanctions on Russia, such as US, EU member states, the UK, Japan, Canada, Norway, Singapore, South Korea, Switzerland and Ukraine.
The G7 therefore chose to challenge Putin, with German Finance Minister Christian Lindner telling Bloomberg: “We cannot accept any blackmail.” Ahead of a possible supply emergency, Germany and Austria have started to ration gas.
In spite of such friction, European markets performed well, with the German DAX rising by 1.0% during the week. In the UK, meanwhile, the FTSE 100 rose by 0.7% and the mid-cap FTSE 250 rose by 1.3% – in spite of a sharp drop in Sterling last week.
As for bond markets, it was a somewhat more challenging week. Central banks are increasing interest rates in a bid to manage inflation, and in turn, investors are becoming more cynical regarding the outlook for the asset class.
The Federal Reserve (the US central bank) has pledged to action a series of rapid interest rate rises this year. As a result, investors have opted to sell US government bonds, leading to a rise in the yield on a two-year bond, which moves inversely to its price.
Pessimism in the air
Investors were alarmed last week, as parts of the US treasury yield curve inverted for the first time since 2019. In so-called normal times, investors holding longer-duration bonds would anticipate being rewarded with higher yields for taking on more risk over a longer duration.
A yield curve inversion suggests that investors have a pessimistic outlook for the world economy. On the other hand, however, while this can be a sign of recession, it has so far only been a brief adjustment. Indeed, commentators would examine an extended period for a more reliable indicator of a future recession.
The Fed is due to release minutes from its latest policy meeting this Wednesday, with undoubtedly each word scrutinised for any clues about the future trajectory of interest rates.
Soaring energy prices, coupled with 30-year-high inflation, mean UK households are facing a cost-of-living crisis. On Friday, the energy price cap rose from approximately £1,300 to almost £2,000, while official forecasts propose it will rise to £2,800 in October.
The Office for National Statistics (ONS) issued data last week, which reported that the household saving ratio dropped by 0.7%, to 6.8% between the third and fourth quarters of 2021. “It shows that households are willing to adjust their saving behaviour to carry on spending,” commented Paul Dales, Chief UK Economist at Capital Economics. “A continuation of this trend is the key reason why we suspect that the economy will probably avoid a recession this year, even as real incomes fall further.”
Granted, the short-term outlook might currently appear discouraging – with both equities and bonds having their fair share of struggles so far in 2022, together with rising inflation impacting the daily lives of many – and therefore, investing in a diverse portfolio for the long term continues to be the best way for many investors to meet their goals and objectives.
“One lesson that we have yet again from the opening months of this year is how difficult it is to predict financial markets,” comments Joseph Wiggins, Director of Liquid Markets at St. James’s Place. “It’s impossible and dangerous to try to predict with any confidence what will happen over short-term periods.”