by Nikolay Vanyov
The situation at the international markets in the beginning of August discovered some surprising trends which give us a hint that investors see an opportunity for general change.
Inflation remains the leading economic topic, which is caused (directly and indirectly) by the geopolitical state and the war in Ukraine. Counteraction to Russian aggression there seems to be entering a key, but possibly longer-lasting phase, with the outcome remaining too unclear. However, the grain export agreement brokered by Turkish President Erdogan appears to have opened the door to wider negotiations and a favorable outcome. Inflation also showed signs of cooling, with the key indicator of US consumer prices slowing from 9.1% year-on-year to 8.5% at the end of July. A delay which with its dept kind of surprised the analysts. In the core of the price increase continue to be energy carriers, but there we also see signs of a slowdown, with even Brent crude falling below the levels before the start of the war in Ukraine. However, uncertainty remains the leading factor - will there be and exactly how deep will the energy crisis in the EU be given the uncertain supplies of Russian gas in the fall and winter.
Central Banks: Where's the Right Formula Between Lower Inflation and Recession Globally, central banks consider tackling inflation as their key priority in 2022. It couldn't be any other way, as the rapidly rising cost of living is hitting large sections of the population hard, increasing the risk of many of them falling below the poverty line. The US Federal Reserve again showed the most decisive action, raising rates to 2.50% with a final step of as much as 75 basis points. A key element in this policy was Fed Chairman Jerome Powell's statement that Fed economists no longer fear a recession because of the sharp rise in interest rates. The latest economic data confirmed his confidence.
In Europe, the situation is completely different. European economies are significantly more exposed to the risks of Russia's geopolitical moves, and the fundamental stability of the economies is incomparable to that of the US. Against this backdrop, the Christine Lagarde-led ECB took a somewhat correct (and absolutely expected) wait-and-see policy. The increase in the main rate to 0.50% was the first in 11 years, and it was done after it was announced more than a month in advance. One more time the focus of the ECB falls as on the fight against inflation, as well as on the protection of the more vulnerable economies of the eurozone, and Lagarde seems to have hit the right track with the announcement of the program to control the spreads of the main euro-government securities. Overall, in the beginning of August the storm in the euro zone seems to be under control, but the big question, of course, is what will happen in the beginning of the of the heating season in Germany.
Stock markets – the bears sleep their summer sleep. The news from August were positive for the stock markets, as from the middle of July the broad gauge of US markets, the S&P 500 index, rose more than 11%, and a continuation of this move could take it to levels higher than those immediately before the start of the war in Ukraine. Despite higher systematic and non-systemic uncertainty, the European stock markets do not stay far behind with the German DAX increasing with little less than 10% for the same period.
Sectorally, things look different, of course. For now, the financial services and banks sector is emerging as the riskiest, where rising yields are starting to damage investment and credit portfolios (but not in Bulgaria, where the sector recorded a record six months as net operating profit). On the other hand, sectors such as video streaming, aviation, etc. are making some progress.
Securities: Is the worst behind our back
In the Eurozone, the serious growth of benchmark bond yields at one point caused a serious dose of anxiety among economists. By early August, that anxiety seems rather dulled. Ten-year German bunds retreated from levels of over 1.50% yield to maturity, trading as low as 0.90% as of August 10, with a view to falling if cooling inflation takes hold. Investors understand that after consumer prices calm, with the possibility of a Eurozone recession, the ECB will quickly switch to stimulus measures, one of the first of which will be a new liquidity injection and asset purchase program, the results of which have historically been quite clear.
In the US, Treasuries moved in the same direction, with the main topic being expectations of a reduction in aggressiveness by the Fed in terms of interest rate hikes. For now, it remains unconfirmed (and even denied by the latest statements of the members of the Committee on Open Markets). Recession risks in the largest economy also appear somewhat understated, at least as far as the inversion in yields between 2-year and 10-year Treasuries is concerned. Although many questions about future economic development remain to be answered, at least for now, income levels above 3.20% in the ten-year matriculation seem unsustainable.
Raw materials, energy carriers and metals – is the end of inflation coming?
The fundamental rise in inflation began already at the end of the summer of 2021, long before the start of the war in Ukraine. Oil has returned to levels below $100 per barrel of Brent, with prices down nearly 30% from the peaks of March and April. The situation with natural gas, especially that traded on the Dutch exchange, as a price maker for Europe, looks different, with prices close to the highs since mid-March. Overall, energy sources remain the most significant factor in increased uncertainty.
As for agricultural products, the contract between Russia and Ukraine on the export of Ukrainian grain is having an impact on the markets. The fall in the prices of staple foods in the period May-August 2022 is between 30 and 50%, and this factor will certainly contribute to calming inflation.
In general, the main raw materials and commodity prices are decelerating at a pace seen amid heightened recessionary expectations. However, investors should not forget the severe declines followed by even more severe price increases at the outbreak of the Covid pandemic in March 2020. Despite the fundamental differences between the situation then and now, the analogies are not inadmissible, especially since central banks are ready to intervene even more aggressively in the fight against the recession.
The possible scenarios A number of analysts and politicians define the coming months as crucial, and in Europe they are preparing for rather unpleasant scenarios related to the shortage of gas and energy. However, the markets seem to indicate that the pessimism is largely unwarranted. On the one hand, reasonable expectations are for a moderate recession, if it ever comes to one. On the other hand: there is always the possibility of an end to Russian aggression against Ukraine and some type of normalization of energy supplies to the Old Continent. We must not forget that the change in the energy policy of the EU is already a fact, although the short period of time does not allow the liberation from energy dependence on Russia, in a slightly longer term the security of the continent will certainly be improved.
If we judge by the development of the international financial markets in July and August, then indeed the winter will not be so freezing, the recession - deep, and the economic prospects beyond 2022 look more positive. For the realization of such a scenario, the months from October to November will be key from a political and economic point of view.
The riskiest for now is the financial services sector and banks, where rising yields are starting to damage investment and credit portfolios
