The first quarter of 2022 has been a challenging time for financial markets and global economy. Inflationary forces continued to intensify in key regions, which suggested interest rates could be raised more quickly and more aggressively than previously anticipated. The threat of energy prices spiraling and food shortages owing to the ongoing conflict in Ukraine caused further unease in the world. The opening stanza of a Federal Reserve tightening cycle have weighed on equities and fixed income. Further Covid lockdowns in China also hampered sentiment towards risk assets, and could add to inflationary pressures. Various shutdowns and the likelihood of supply-chain interruptions seem likely to push prices higher.
However, headline inflation is very likely to fall as temporary pressures, including those stemming from energy prices, ease. We expect core inflation to remain elevated across the developed world as shortages persist and wage growth picks up. Though the U.S. economy still has considerable positives going its way, the amalgam of headwinds underscored the financial hazards in a world undergoing rapid change. Russia’s invasion of Ukraine tops the list of unknowns, both for its immediate impact and for the financial and geopolitical effects that could reverberate into the future. Western allies imposed a stairstep of punishing economic sanctions that included export controls, severed U.S. trade ties and freezes of Russian assets held abroad. In the near term, much could depend on the length and intensity of the war, and how successfully the West can contain energy prices, given Europe’s heavy reliance on Russian crude oil and natural gas. The Russia/Ukraine war is a humanitarian tragedy that carries implications for the world order well beyond the scope of this blog, and it will continue to drive headlines — potentially for quite some time.
While inflationary pressures remain elevated, many EM central banks have continued to respond with orthodox monetary policy, which is a positive. The growth and inflation dynamic remains critical. China also remains a critical factor. Decreased consumer confidence in the property sector has created broad concerns. That said, targeted policy easing has begun in an effort to stabilize the market. This means that most central banks will still need to raise interest rates, and in several cases by more than markets expect.
Following the increase in interest rates in March, all eyes were on the next Federal Reserve Board meeting in early May to see whether borrowing costs will be raised again and, if so, by how much. Growth is likely to disappoint this year as high inflation erodes purchasing power, labour shortages persist and fiscal policy support wanes. But the Federal Reserve will push ahead with monetary policy tightening nonetheless and we expect the fed funds rate target range to reach between 2.00% to 2.25% by end-2023. More encouragingly, unemployment in the US fell to 3.6% in March, only a whisker above the pre-pandemic level of 3.5%. Wage growth has picked up too, partly due to labour shortages in some sectors. Nationally, average hourly earnings are up 5.6% over the past year; double the average rate over the past 15 years.
Until recently the European Central Bank was not expected to amend monetary policy settings this year. Persistently high inflation, however, and the prospect of intensifying pricing pressures owing to the war in Ukraine has prompted investors to revise these forecasts. The conflict in Ukraine is affecting economic prospects for the broader region. Rising fuel costs and risks of energy shortages have dampened consumer confidence in both France and Germany, for example. Particularly high and persistent CPI inflation will prompt the Bank of England to raise interest rates faster than most expect this year and there is a risk of further hikes in 2023.
Economic activity levels in China in the March quarter were quite resilient and supported a better-than-expected growth outcome. The latest wave of infections has clouded the outlook for GDP growth, however, and prompted authorities to suggest stimulus will be ramped up to help support activity levels and investor sentiment. While Omicron may exacerbate supply shortages, inflation will remain well below 2%, allowing the Bank of Japan to keep policy very loose. Growth will be stronger this year than last in India and policy rates will be hiked by more than most expect. Separately, data confirmed that energy demand has fallen sharply in China. Oil consumption is down the most since the initial Covid shock two years ago, owing to the latest shutdowns.
Australia & New Zealand
Australia is set for a year of strong growth, but New Zealand is doing its best to get stabilized. 10-year Australian Commonwealth Government Bond yields closed the month 29 bps higher, at 3.13%; the first time they have traded above the 3% threshold since the middle of 2015.
Inflation pressures are even stronger than elsewhere, and interest rates will rise much further.
Bottom line: The rest of the year will likely give us more clues about the durability of the expansion as rates continue to rise. And, hopefully, it will bring a quick and just peace for the besieged people of Ukraine. Transformative change requires deliberate, focused, coordinated action from visionaries committed to a new future.
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