Your weekly economic update from the team at FXD Capital
USD reached its highest level since July 2020 as news continues to build around a Federal Reserve rate rise over the coming months. On Wednesday, chair Jerome Powell rather ambitiously refused to rule out whether the Fed could raise rates at every policy meeting this year. Markets have already priced in four-to-five 25bps rate rises, which along with geopolitical concerns, is why risk markets have seen a volatile and red month so far in January
Powell’s gunslinger attitude means every policy meeting will be “in play” this year. That kind of meeting that happens in July that disappears before it even arrives will be under constant scrutiny this year. Consequently, expect volatile months leading up to meetings, decisions being priced-in by markets, and the aftermath of things unwinding if the central bank fails to reciprocate with consensus.
Several stock indices have entered correction territory in 2022, meaning losses of more than 10%. While interest rates and inflation are a central focal point for such behaviour, broader forces are at play. There is a genuine probability that after the Winter Olympics in Beijing end next month, Russia may invade Ukraine and seek to march to its capital, Kyiv. There has not been a war in Europe since the breakup of Yugoslavia 30 years ago, and an invasion of Ukraine will be a far more significant macro event.
Everything going on in the markets now is a potent mix of inflation concerns and a war with direct and indirect participation from major world powers (US, EU, UK, Russia and China). The energy crisis unfolding over previous months is a canary in the coalmine for a Ukraine war, which has also given jitters to stock markets, following continual inflation concerns. As such, the only kind of assets performing well at the moment are doomsday ones – think, gold, tobacco, defence. While Bitcoin is often touted as an inflation hedge, it is also amid a severe correction due to the forces at play – mainly mining supply, electricity prices and holders selling it to cover losses.
Another point exacerbating stock prices is the prevalence of leverage in markets. For years, traders ranging hedge funds to basement-dwelling retail investors have harnessed cheap credit to fund leveraged punts. But, in the wake of rising yields and falling stock prices, such trades are being unwound to meet capital calls, with the ripples further crippling the bids on stock prices.
Bulls are smelling discounts on offer, and 2022 could be a year that sees a lot of opportunistic M&A. A year ago, Peloton was seen as the future of fitness, now, it’s worth less than 20% of what it was and is being pilloried as an ostentatious exercise bike business. Larger companies may see opportunities to buy lockdown heroes and bolt them into more extensive consumer plays. It’s also a case that investing has changed on a retail level; more investors are interested in markets and see stocks as brands to buy and hold with “diamond hands”. While previous corrections have seen sell-offs snowball, there is a new “known unknown” in markets of the retail investor, still flush with cash from lockdown savings and willing to ignore the newspaper columns and continue to buy up stocks that align with their morals.
While the 2008 recession was instigated by high personal leverage and overvalued housing stock, 2022 exhibits different conditions. While houses are at prohibitive levels, interest rates sit hundreds of basis points below what was the norm back then. The effect of a recession is likely to be death by a thousand cuts. Energy bills up 5x, small interest rate increases gnawing away at take-home pay and the potential domino of minor job cuts in certain pockets of the economy. While many, including myself, can pontificate about what will come, the looming prospect of a Ukraine conflict is of most concern. We live in the most prolonged period of peacetime ever in the history of humanity, and there is no muscle memory about what an escalation could mean. While World War 3 is probably not on the cards, the vortex of geopolitics, supply chain concerns, a refugee crisis and energy volatility will probably be the main drivers of markets in 2022.
All the best for the week ahead
Alex
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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