May 20, 2022
The initial fallout from the war was a significant factor in global capital markets experiencing their weakest quarter since the onset of the pandemic. However, with little sign of a resolution, the primary focus of investors has shifted towards two other catalysts influencing markets: tighter monetary policy to address persistent and potentially runaway inflation without stalling growth and continued Chinese lockdowns in the country’s renewed battle against COVID. Such concerns are causing weakness across asset classes. For only the second time this century, April saw the combination of the S&P 500 falling more than 5% and US Treasuries losing more than 2%.
Some of this move in equities was directly linked to the war – such as the higher energy prices and supply chain disruptions in goods such as grains. However, a wave of risk aversion has swept through global markets on concerns that the Federal Reserve (Fed) has little room for a change of course in its rate-increase and quantitative-tightening plans, which could bring about a recession. For context, the S&P 500 has now suffered its longest streak of weekly losses since 2011, and global sentiment took a further knock as Chinese Premier Li Keqiang warned the nation’s employment situation had turned grave because of Covid restrictions. In addition, a slew of macro data missing estimates in the middle of May exacerbated investor concerns. The situation has impacted some of the world’s biggest brands. Companies including Apple have cited the Chinese lockdowns as having a direct impact on revenue expectations, both due to reduced consumer demand and supply chains not functioning as smoothly as normal.
On the fixed income front, recent weeks have been challenging for sovereign bonds, with Treasuries losing ground for a fifth consecutive month, whilst EU sovereigns also remain under pressure. The closely watched US 10-year yield has passed 3%, driven by the continued hawkish rhetoric from the US Federal Reserve, with Chair Powell suggesting the US Federal Reserve may be readying a series of 50 basis point hikes.
The Russian equity benchmark – shut for three weeks from the outset of the invasion – has trended higher in recent weeks on two key drivers. First, high commodity prices have mitigated some of the impact of Western sanctions. Second, the Bank of Russia cut interest rates more than forecast to support the economy. This has further boosted the recovery of the ruble, which is now stronger than before the conflict, changing hands at below 65 per dollar in Moscow. Bloomberg estimates that Russia will earn nearly US$321 billion from energy exports this year, an increase of more than a third from 2021, and leading to Russia’s largest current-account surplus in almost three decades, according to publicly available data going back to 1994. Volumes remain significantly below average, with some commentators stating that spot prices on screens may not be reliable.
One area of the market that has remained elevated throughout the conflict is commodities, not least given the recent move to stop Russian gas flows into Poland and Bulgaria. Brent crude oil has risen for five consecutive months, most recently on the back of European Union plans to ban Russian crude oil over the next six months and refined fuels by the end of the year.
However, there has been some downward pressure on oil given coronavirus lockdowns in China, which have raised the prospect of lower near-term demand. Agricultural products – particularly grains – have jumped in price during the conflict, given Ukraine’s importance to that market. India – which had been expected to pick up some of the supply in place of Ukraine - placed a ban on wheat exports to rein in domestic prices, which has further supported the price. Gold has weakened recently in the face of rising yields and a stronger dollar, though it was supported during the initial sell-off during the invasion as a form of safe haven.