Higher inflation and rising interest rates
January and February have seen significant rises in interest rates in the US and Europe. Both short-term and long-term interest rates have risen in the first two months of the year. The yield on a 10-year US government bond has risen from 1.5% at the start of January to 2.1% in mid-March. These rises are a result of the market anticipating several interest rate hikes by the US central bank, the Federal Reserve, during 2022. The Federal Reserve has been signalling for some time that persistently higher inflation will lead to interest rate rises.
Higher inflation is a recurring theme. It is driven in particular by higher energy and oil prices, whilst everyday consumer goods such as second-hand cars and food have also risen significantly in price. In the US, the Consumer Price Index (CPI) has risen by 7.9% year-on-year, which is the highest rate of increase since 1982. Inflation has also risen significantly in Europe, reaching 5.8% in February.
Invasion of Ukraine leads to market uncertainty Russia’s invasion of Ukraine has also contributed to increased volatility in the financial markets. War on the European continent is creating uncertainty about growth in Europe. Economically speaking, Russia and Ukraine are relatively minor players on the global stage, but many companies in Europe rely on a stable supply of energy, such as natural gas or oil. Russia supplies around 30 per cent of Europe’s total natural gas consumption, and uncertainty over security of supply has doubled the price of natural gas.
Greater uncertainty, higher interest rates and rising inflation have proved a bad combination for risk assets. Both share prices and bond prices have fallen in January, February and March. High-yield bonds have so far delivered a negative return of -4.7% year-to-date measured in Danish kroner. Global equities, as measured by the MSCI All Countries index in Danish kroner, have delivered a negative return of -9.4% year-to-date, whilst the leading Danish OMXC25 index has returned -12.3% year-to-date.
The US dollar has strengthened against the euro, as many investors view the dollar as a safe-haven currency when volatility rises and stock markets fall. Since Russia’s invasion of Ukraine, the dollar has strengthened by 4%.
Whilst the media is primarily focusing on Russia’s invasion of Ukraine, the stock markets will also be keeping a close eye on central banks and their rhetoric in the coming period. An escalation of the situation in Ukraine will lead to negative fluctuations in the financial markets, whilst the markets will react positively to a de-escalation. If the situation in Ukraine de-escalates, the focus of the financial markets will shift more decisively towards central banks’ monetary policy. The markets are already anticipating further interest rate rises from the US Federal Reserve, and the European Central Bank is also beginning to signal a tighter monetary policy. A tighter monetary policy could dampen expectations of economic growth, which may lead to corrections in share prices. In LD Pensions, they believe that the coming period will continue to be characterised by uncertainty.
