As the opening quarter of the year draws to a close and we enter Q2, we reflect on what has definitely been a memorable three months for markets. The period has been characterized by accelerating inflation amid surging energy prices which have had a series of consequences for financial markets. There has been a notable hawkish shift in both interest rate expectations and central banks’ outlook, which in turn has seen bond yields rise significantly.
Elsewhere, the main equity indices have suffered falls as investors have been adjusting to the higher inflation and interest rate outlook.
The second half of Q1 was a particularly volatile period across financial markets, as investors struggled to assess the implications for economies of the invasion of Ukraine, not to mention the major humanitarian crisis that is still unfolding as each day passes. Inflation will almost certainly now rise even further in 2022, which has negative implications for growth in advanced economies.
We continue to believe that the risk of a global recession this year is minimal; however, it must be said that a more hawkish Federal Reserve does slightly increase recession risks for some time in the second half of next year or 2024. That said, positive corporate earnings, above-trend growth, and still accommodative financial conditions suggest risk assets can still perform well, even as the Fed raises interest rates.
Also supporting equity markets on a relative basis over bonds is that despite the increase in bond yields year-to-date, real yields adjusted for inflation, remain negative. It is further worth noting that despite the ongoing conflict in Ukraine, equity markets have now recouped practically all of the losses incurred since the invasion on February 24th while in the US all three major indices are in fact higher than their closing levels on the eve of the invasion.
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