29 November 2022
Is falling inflation on the horizon?
Last week, equity markets showed a positive trend as investors were given some room for optimism regarding the future of the world economy.
The fall in prices from COVID-19-related peaks can be seen in recent data for factory gate costs and shipping rates. One of the main factors contributing to this year’s high inflation has been constrained supply chains, so if they start to loosen up, inflation may start to decline as well.
For example, Capital Economics estimated that stable shipping costs would result in a 0.3% reduction in the overall level of inflation in 2023 (this is considering 2023 inflation will be calculated against the current 2022 levels which are already high). However, the current decline in shipping rates could prevent inflation from rising by 0.5%.
Chinese equities increase despite new COVID-19 restrictions
Oil prices fell for the third week in a row as the mood remained negative due to growing demand worries regarding China, which only furthered the sense that inflation may have peaked.
China, the world’s largest importer of oil, had record daily COVID-19 cases over the last week, which resulted in the reinstatement of tight restrictions for a number of important cities across the country. This has raised worries that there may be another slowdown in Chinese economic growth, which would be an additional hit to worldwide recessionary worries and oil demand.
In the past, these lockdowns would have harmed Chinese stocks, but last week, the Shanghai SE Composite saw a small increase (0.14%). Despite additional lockdowns due to COVID-19, Chinese stocks continue to keep their value and indications of a wider economic slowdown may indicate that a significant portion of this bad news has already been reflected in their prices.
This notion will likely be challenged as the week goes on in light of anti-lockdown protests that took place over the weekend in major cities all around the nation.
All eyes on US and European central banks
Eyes have shifted to central banks to see how they will respond as inflationary pressures start to ease. The majority of 2022 was devoted to hiking interest rates from their COVID-19 lows by the US and European central banks.
The US Federal Reserve has set the standard, raising its central rate repeatedly by 0.75% over the year. However last week, the Fed hinted that it might be time to slow the pace soon. According to minutes released last week, a 0.5% hike could now be expected next month. Global equity markets were lifted as a result.
The US had a shortened trading week due to the Thanksgiving holiday last week. But markets remained busy for most of the week, and saw the S&P 500 increase by 1.5% to close the week above the 4,000 mark for the first time since September. The NASDAQ also increased by 0.7%.
This optimistic outlook extended its reach to Europe, where the FTSE 100 and the MSCI Europe (excl. UK) both saw gains of 1.37% and 1.43%, respectively. The markets will be closely monitoring the release of European inflation data this coming week.
Should markets prepare for disappointment?
Even while investor sentiment is improving, it’s crucial to keep a realistic perspective. According to David Bowers of Absolute Insight:
“Equity gains in recent weeks suggest investors believe a shift from rapid tightening (0.75% per meeting) to a slower pace (0.50%), may soon signal a Fed pivot. We don’t think that is the case. The real pivot comes, on the most generous interpretation, when rates stop rising, and more realistically, only once the Fed starts cutting rates. Divining precise historical pivot points is something of a ‘dark art’.”
In the same vein, Mark Dowding, Chief Investment Officer at Bluebay, warned:
“We ourselves are nervous that a more dovish outlook has been priced prematurely and with financial conditions noticeably easier than they were before the time of the last Fed meeting, when they hiked by 0.75%, there is a risk that markets could be disappointed by the FOMC into the end of the year.”