The problems only seem to get worse as the first half of 2022 draws to an uncomfortable close: inflation is rampant, interest rates are up, energy markets remain difficult as Putin’s bloody war grinds on, and China’s COVID policy continues to stifle supply chains… and now we have a change in Prime Minister.

Interest rate (bond) markets exhibited some extraordinary volatility over the quarter. The US Federal Reserve pushed up their base rates by three-quarters of a per cent in June to 1.75%. This was accompanied by much ‘hawkish’ commentary and hints of more big moves to come; central bankers are finally being rattled by inflation. The following day the Bank of England raised the Base Rate to 1.25% with equally dire warnings – it is a shame that it sounds so much as if the Bank were chewing their collective nails and merely following events.

UK Gilts suffered steep falls as interest rates increased for all periods, the ten-year Gilt has sunk 13% this year, taking the yield to 2.5%, while the thirty-year Gilt has suffered a 32% fall. The pattern has been the same in Europe with an extraordinary turnaround in German ten-year bonds from negative yields at the start of the year to a June peak of 1.75%.

Concerns have now turned to fears of recession; economies are slowing rapidly and aggressive tightening by central banks could easily tip them into recession. Perversely, this then takes on the feel of a self-correcting mechanism as expectations of recession act to dampen activity and inflation and limit the scope for central banks to raise their rates. Recognising this, bond yields turned down again at the end of the quarter and there are (some) early indications of a rolling-over in inflation.

It would/will be an odd sort of recession against a backdrop of robust labour markets and household and corporate balance sheets in good health. Possibly we have been overly conditioned by two dramatic (but exceptional) recessions following the Global Financial Crisis and COVID, a rather milder affair is the more likely outcome.

Unsurprisingly, equity markets have not enjoyed all this uncertainty and further falls in June left most world indices down by around 20%, though FTSE 100 remains an outlier thanks to Shell (et al). The FTSE 250 Index is down 21% and feels rather more representative at present. American markets also fell around 20% over the first half and the more technology-biased NASDAQ Index is down by around 30%. It is not yet clear that equity markets have ‘found a level’, more falls would not really be a surprise. But, it is beginning to feel as if a lot of concern has been ‘priced-in’ to the markets by now. Similarly, the rates available in the corporate fixed interest markets are looking attractive, in stark contrast to the miserly rates that have been available for the past couple of years.

The full Quarterly Review is available here. 

July 2022

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