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Many investors entered 2022 with the expectation that the markets would be more volatile this year, anticipating that central banks would begin to remove pandemic stimulus measures and normalize interest rates. After all, after close to two years of dramatic increases in fiscal spending and ultra-low interest rates, inflation is at levels not seen since the 1980s. It seems like it’s time to deal with this problem.
Inflation can come from many sources, and certainly some of this recent move can be attributed to problems in the supply chain, but regardless, it has pushed into all levels of the economy and is affecting company operations, borrowing costs and margins. The bond market began to signal the need to hike interest rates last summer as bond yields bottomed. They have now returned to pre-pandemic levels.
Once it became widely understood of the need for rates to increase, one of the biggest worries from the equity market was of a policy error: Could the Fed be hiking too soon or too quickly? In mid-January, this fear caused some selling as economic data began to slow.
However, by mid-February, on the back of strong corporate earnings and better economics stats, global markets felt much more comfortable with higher rates. This resulted in the expectation toward a 50-basis point (bp) increase in the fed funds rate at the March meeting and an equity market that had recovered a great deal of the selling from January. Like all best-laid plans, this now is at risk of being too optimistic.
Tensions along the Ukrainian border with Russia had been increasing through the year, but to most observers it seemed unlikely to amount to anything. That all changed as the Beijing Olympics ended with the Russian invasion of Ukraine on Feb. 24. It’s now time for global bankers to come up with a new plan.
As the invasion began, commodities spiked, safe-haven assets outperformed, and bond yields fell. Odds of the 50-bp rate hike had been over 80%, but fell below 10%. It’s not often central banks are aggressively tightening during global unrest, and these expectations needed to be adjusted.
It’s widely known that markets hate uncertainty, and what we are witnessing in Europe is increasingly hard to predict. We can hope this crisis ends quickly but we also must prepare for the worst if it doesn’t.
Central banks are in an increasingly difficult position, balancing the need to battle inflation and normalize rates while providing stability and support to global markets if sanctions begin to impact trade and banking functions.
For the month of February, markets weathered the volatility well and finished off the recent lows. Negative investor sentiment remains very high, at levels not seen in decades. Contrarian thought would suggest that means all the bad news has been priced into the market, making it difficult to get too bearish. But this all could change quickly. Investors need to remain nimble with active over passive strategies. Risk management is critical, and being positioned towards commodities as an inflation hedge has been working.
The headlines over the next few weeks will be key to determining our next moves. We can only hope for a peaceful resolution in Ukraine, but we need to be prepared if that isn’t the case. Everyone spent the last few years awaiting a return to normal after the pandemic, but it seems the only normal we are getting is a reminder that investing can be volatile and must be handled accordingly.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
Content copyright © 2022 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Thoughtful” page of the Purpose Investments’ website. Used with permission.
Charts are sourced from Bloomberg unless otherwise noted.
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