By Andrew Hardy, Director and Investment Manager at Momentum Global Investment Management
After nearly two years of virtually unbroken gains from the pandemic lows, investors were optimistic 2022 would bring more of the same.
Far from the case, it has turned out to be one of the weakest starts to the year on record across many asset classes in the face of intense uncertainties about inflation, growth, and the unfolding impact of the war in Ukraine.
With the pendulum of market sentiment now swinging well into ‘fear’ territory, some perspective is called for. Although the outlook remains very challenging, and volatility is likely to remain elevated, uncertainty cuts both ways and there are some reasons to believe that markets may stabilise before long.
- Although deteriorating, the global economy is still in reasonable health. Lead indicators such as Purchasing Managers Indices (PMIs) are still indicating expansion ahead, the unemployment rate in the US is near a half-century low, and global GDP is expected to grow by 2.9% this year (latest World Bank forecast).
- Policy conditions are still relatively loose by historical standards. For now, nominal interest rates around the world remain very low and are deeply negative in real terms adjusting for current inflation. Fiscal policy remains supportive as well, with continued deficit spending and little sign of austerity ahead. While overall financial conditions have tightened, it’s been from very loose levels.
- Tightening is being front-loaded and a lot has been discounted. Although policy rates are still low, forward guidance/jawboning from the Fed, BoE and ECB has led to an extremely sharp rise in rate expectations and bond yields e.g. the US 2 year Treasury yield has gone from 0.3% to 3.4% over a year and the 10 year from 1.1% to 3.3%, both at decade-plus highs. It’s been the weakest start to the year for investors in US Treasuries in over 200 years. Although tightening has further to go much of the rise in bond yields may be behind us, and longer term yields in the US are now offering positive real returns.
- Inflation is likely to peak soon. This remains the biggest unknown but it looks likely that inflation will start to moderate soon and may come down faster than expected as pandemic induced supply chain problems ease, year on year effects subside, monetary tightening starts to bite and growth slows.
- Longer term inflation expectations remain well anchored. Estimates of longer term inflation have risen from pandemic lows but remain within the range of the past 20 years – the so called ‘5 year 5 year’ inflation rate (the expected annualised rate of inflation for 5 years starting in 5 years’ time) stands at just 2.3%. The market expects inflation levels to revert, even if sticky for a year or two.