The week that was

As the plight of Ukraine worsened and Putin appeared to be doubling down on indiscriminate shelling of civilian housing and infrastructure, both sides intimated during the week that there might be room for an agreement that involved a neutral (non-NATO aligned) Ukraine. That was enough to send European stocks 10% higher. By the same token the long-term inflationary consequences for the global economy are also becoming increasingly entrenched and most markets were down for the week as interest rate expectations drifted back up. Commodity prices were generally down on the week but remain well up since the Russian invasion of Ukraine and volatility has been extreme. Last week trading in Nickel was suspended as extreme volatility threatened the solvency of a Chinese Nickel producer.  Gold was up by almost 6% during the week but drifted back to end the week flat. In that context the Japanese and Australian markets were a relative oasis of calm, ending the week flat after a less eventful week with gains from the big 4 Australian banks offsetting losses from the iron ore miners.  The threat of higher interest rate pressures once again weighed on US markets which fell sharply at the very end of the week with the S&P 500 down 2% for the week and the Nasdaq was down 4%. All of this though needs to be seen in the context of the last few weeks since the war started and indeed the start of the year when interest rate expectations started to rise.

Since the start of the year both the US market and mainland Europe are down just over 10% but for different reasons. The US fell the most earlier in the year when interest rate expectations were rising the fastest while most of Europe’s falls have happened since February 24th when the Ukraine invasion started. Emerging markets had also been resilient but sold off sharply last week as the potential delisting of some prominent Chinese tech stocks in the US was raised by US regulators. India and most South American markets, by contrast remain up of the year so far.

Credit spreads eased a little again but the rise in spreads all year has been fairly gradual, all things considered. This means that investment grade credit and high yield bonds are both down around 3-4% so far this year (investment grade bonds typically carry less credit risk but more interest rate risk than their high yield counter parts).   Lastly, the US Dollar continue to reclaim it’s safe haven status and was generally stronger against most currencies, and notably against the Australian  Dollar and the Pound while the Japanese Yen was the strongest major currency, up over 2% against the US Dollar.

Before last week’s US inflation number for January came in at just under 8% (year on year) the situation in Ukraine had led the market to expect a 0.25% rise in interest rates in the US (from 0.5% which had become a growing consensus). The inflation number was only as high as had been expected and even though this is the highest in 4 decades, much of it is widely expected to fall away as supply chain disruptions ease. However, the underlying composition was broader than many had expected and there are signs higher inflation expectations are creeping into the ‘stickier’ components of inflation and into wage expectations. This has reignited gears that the Fed might feel forced to move more aggressively with a 0.5% rate hike later in the week. Even though the RBA is doing its best to drag its heels given our increasingly different context, our long-term rates are very much tied to those of the US and so far this year they have moved up more rapidly than in the US. This week could again be quite choppy but hopefully Australia remains the still backwater for now.