By Tim Sharp
It has been a testing month for global bond markets, despite inflationary pressures from Central Banks and the Ukraine Crisis market pessimism has been running on stretched levels. When bond yields go up there is an inverse relationship on the price which will go down. An inverted yield curve, when short-dated bonds yield more than long-dated bonds, could be a sign that a recession is coming under normal circumstances. Central Banks look to combat inflation by raising interest rates. Some would argue that Central Bank intervention since the global financial crisis has blunted the signalling skills of the bond markets, but we believe history suggests that the US Treasury yield curve remains the most accurate predictor of recessions. During March, the US Treasury yield curve has flattened considerably with the yield differential between two-year and ten-year benchmarks have reduced to 0.02%, while the five-year to ten-year part of the curve has inverted 0.11% as at month end. The speculation continues and time will tell if central banks can engineer a soft landing.
In the Eurozone, growing investor uncertainty over future ECB (European Central Bank) rates have boosted fixed income volatility, which is assisting the rise in bond yields. Eurozone benchmark bond yields have been soaring recently, with 10-year Bund yields rising by about 75bps so far in March, which is cheapening Bunds. This rising trend in eurozone bond yields reflects the growing investor uncertainty over the future trajectory in ECB policy rates[i]. Price pressures intensified substantially within the Eurozone in March, headline inflation hit 7.6% in Germany and 9.8% in Spain, both statistics were well above expectations, and both at 40-year highs. Pressure on policymakers to act will rise as the market prices in almost three quarter-point hikes from the ECB by the end of the year. The story of inflation within the eurozone is mainly being led by the increase in energy prices and supply disruptions[ii].
In the US, the 10-year U.S. Treasury yield hit a fresh two-year high Friday 25th March as investors anticipated a more aggressive Federal Reserve tightening cycle. The 10-year rate hit 2.50%, its highest level since May 2019, having started the week near 2.15%. The yield on the 30-year Treasury bond jumped 8.1 basis points to 2.59%. “If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so,” Powell said in a speech to the National Association for Business Economics. The increase in Interest Rates comes as Powell has said “inflation is much too high” [iii]. As we have previously seen from January this year, there could be as much as seven interest rate hikes this year by the Fed.
Europe has started to feel the effects of the Russia-Ukraine crisis for which unfortunately no end is currently in sight[iv]. Investors have grown increasingly convinced that the fallout from Russia will have a lasting effect on the region’s economy. We see that output has suffered in countries with a greater supply exposure to Russia, with Germany seeing the largest declines. We have already seen rising energy prices and firms passing on higher costs to consumers. This has also been reflected in stock markets with the Italian MIB Index down 1.02%; the Dutch AEX down 0.48%; The German GDAX down 0.14% and, while the French CAC40 was up 0.30% over the course of the month.
We see that the stocks that have performed the best in March have been quality stocks with good cash flows and low debt profiles. Tech stocks that are predominantly software based have very little debt and are typically asset light. A few examples would include Alphabet, up 3.0% on the month, and Microsoft up 3.2% from the start of March.
Global stock markets have had a late month surge on the possibility of a possible ceasefire in Ukraine and a Russian announcement that its military was cutting back operations around Kyiv and Chernihiv in the North of Ukraine that looks like signs of progress[v]. The MSCI World Index has increased 9.1% since March 8th, 2022.
In Japan the Yen is generally considered to be a safe haven in times when geopolitical and financial tensions are raised, and as an example strengthened against the dollar during the years of the Global Financial Crisis[vi]. However, that is not the case this time as the Yen has weakened against a strengthening dollar by around 6.5% due to its position as a significant energy importer. The Nikkei 225 has been equally disappointing having fallen 5.58% over the course of the year.
Commodity prices have also rallied this past month amongst the growing uncertainty with the Russia-Ukraine Crisis and the resulting disruptions to supply. Russia and Ukraine are two of the world’s largest suppliers of wheat/grain (around 30%) and Russia has temporarily put a ban on grain exports to ex-Soviet Countries (March 14th) [vii]. US retail gas prices ‘at the pump’ have reached all-time highs due to concerns about supply which has been reflected in OPEC reports and US ban on Russian Oil imports[viii], with oil prices reaching $130 a barrel, almost double their price in early December! Prices of Energy have been increasing and energy related stocks have seen surging share prices. Good news for existing commodity investors with the WisdomTree Enhanced Commodity ETF 10.8% stronger in dollar terms in March.
To summarise, March has seen significant rises in volatility and market turbulence driven by the knock-on effects of the Russia-Ukraine crisis. The S&P closed at 4530, and the UK FTSE 100 closing at 7515 both up 8.6% and 8.0% respectively from Month lows on March 8th. There has been a late rally in market prices on hopes of Russia reaching an agreement with Ukraine, however the war is not yet resolved, and it is too early to say that markets will not revisit lower prices. The Wisdomtree Enhanced Commodity ETF has been a strong performer in March hitting all-time highs (1596 up 15.8% from the start of March in sterling terms) while the S&P 500 hit its lowest in March albeit ending the month 6.3% higher than at the start. The iShares Physical Gold was up 8.6% on March 8th although ending the month only 1.4% higher. There will undoubtedly be a knock-on effect due to the restrictions on Russian exports which markets probably still need to factor into pricing. We are in a highly inflationary environment that still needs to be addressed by central banks while attempting to avoid a global recession. The Bank of England has increased UK interest rates in March to 0.75%, the Federal Reserve is still aggressively approaching US Interest Rates, and the ECB is still contemplating its position. Finally, the Japanese Yen once considered a safe haven in times of uncertainty has not lived up to its reputation.
[i] Absolute Strategy Research – EUR bond yields’ shifting drivers – March 30, 2022
[ii] Absolute Strategy Research – Eurozone inflation surge continues – March 31, 2022
[iii] https://www.cnbc.com/2022/03/25/us-bonds-treasury-yields-flat-friday.html
[iv] Absolute Strategy Research – Europe starts to feel Russia-Ukraine effects – March 25, 2022
[v] Bloomberg Points of Return – Be Warned – A Piece of Paper – John Authers – March 30, 2022
[vi] Bloomberg Points of Return – Be Warned – What a Time for Japan to Matter to Markets Again – John Authers – March 28, 2022
[vii] https://www.reuters.com/business/russia-may-suspend-grain-exports-until-june-30-interfax-2022-03-14/
[viii] https://www.reuters.com/business/biden-bans-russia-oil-imports-us-warns-gasoline-prices-will-rise-further-2022-03-08/
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