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…
Bond markets exhibited some extraordinary volatility during the month. The US Federal Reserve pushed up their rates by 75bp mid-month to 1.75%, finally (and belatedly) taking them back up to 2019 levels, with much hawkish commentary and hints of more big moves to come, ten-year US Treasury yields jumped to 3.5% and the two-year to a similar level. The following day the Bank of England raised the Base Rate to 1.25% (50bp higher than 2019 levels) with equally dire warnings as to inflation in coming months – I wish it didn’t sound so much as if the Bank were chewing their collective nails and merely following events.
UK Gilts suffered in turn as rates increased along the curve, the ten-year Gilt has sunk 13% this year, taking the yield to 2.5%, but the thirty-year has suffered a 32% fall, duration, as ever, taking its toll. The pattern has been the same in Europe with an extraordinary turn-around in German ten-year bonds from negative yields at the start of the year to a June peak of 1.75% (a fall in capital value of 17%).
The question now turns to recession, economies are slowing rapidly and aggressive tightening by central banks could easily tip them into recession. This is quickly becoming a central-case expectation in markets. Of course, 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 have turned down over the past seven days and there are 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 generally good health. Possibly we have been conditioned by two (exceptional) dramatic recessions following the GFC and COVID and a rather milder affair is more likely… we shall see.
Unsurprisingly, equity markets have not enjoyed all this uncertainty and further falls over the month are likely to leave the US market down by around 20% over the first half and the NASDAQ around 30%. World indices are also down around 20% though FTSE 100 remains an outlier thanks to Shell (et al) – the 250 Index is down 21% and feels much more representative at present. We must expect some cooling in earnings expectations over the next few months. It is not yet clear that equity markets have ‘found a level’, more down-side would not be a surprise, but it is beginning to feel as if a lot of concern has been priced-in by now.
Similarly, spreads have continued to widen in credit markets and there is little sign yet of respite. But, looking at the UK credit market, it is hard not to think that short-dated yields over 5% on investment grade issues are attractive.
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