Global markets are sinking ahead of a big week for central banks

A trader works on the floor of the New York Stock Exchange (NYSE) in New York City, on June 1, 2022.

Brendan McDermid | Reuters

LONDON — Global stock markets are falling sharply after May’s US inflation reignited fears that central banks will be forced to aggressively tighten monetary policy.

Friday’s highly anticipated consumer price index report was more positive than expected at 8.6% year over year, resurfacing market concerns that action by the Federal Reserve and other central banks could send the economy into a tailspin. recession.

Major US averages closed their biggest weekly declines since January on Friday, and futures look set to further punish losses on Wall Street when the opening bell rings on Monday.

Stocks in Asia-Pacific slumped on Monday, with Hong Kong’s Hang Seng Index, Japan’s Nikkei 225 and South Korea’s Kospi all falling more than 3%. European stocks also fell, with the pan-European Stoxx 600 shedding 2% in the early afternoon as a sea of ​​red swept across global risk assets.

Meanwhile, the 2-year US Treasury yield hit its highest level since 2007 on Monday morning and topped the 10-year rate for the first time since April, a reversal often seen as indicative of an impending recession.

‘punched in the stomach’

Central to the market’s adverse reaction to Friday’s CPI reading is fears that inflation expectations have broadened and entrenched, beyond well-documented ephemeral factors such as supply chain bottlenecks. and energy shocks.

“I think the probability of going into a bear market and indeed a recession has undoubtedly increased as a result of Friday’s punch to the gut, in a way,” Fahad Kamal, chief investment officer at Kleinwort Hambros, told CNBC. on Monday.

Kamal added that there was “very, very little good” in Friday’s inflation report, which indicated that inflation has not peaked and has instead widened across the economy.

“There’s less talk about sex and violence from oil prices and commodities and other things, but in reality, rent is very sticky and it’s a big part of the index. There seems to be a bullish momentum as well, which implies that inflation is going to be with us higher and longer than we expected even last week,” he said.

Richard Kelly, head of global strategy at TD Securities, told CNBC on Monday that both the bond and equity markets were now indicating a recession was looming, most likely in the fourth quarter of 2022 and the first quarter of 2023. .

“In general, if you look at the stock markets, they tell you that the ISM (US index of economic activity) is likely to fall to 50 or below 50 in the next two or three months, and this is part of what the Fed and the central banks have to do to get inflation back under control,” Kelly said.

The 50 mark separates expansion from contraction in the purchasing managers’ index reading, a reliable gauge of economic activity.

“While (the Fed) can’t sit back and say it’s their job to end job creation for now, that’s basically what they need to do if they want to get inflation back under control now,” Kelly added.

All eyes on central banks

The week ahead will be pivotal in the battle against runaway inflation for central banks and global markets.

Federal Reserve officials will meet on Tuesday and Wednesday to discuss their next monetary policy move. The Federal Open Market Committee is widely expected to announce at least a 50 basis point hike on Wednesday, having raised rates twice this year, though market bets on a 75 basis point hike have risen in light of Friday’s CPI figure.

The Bank of England’s Monetary Policy Committee will announce its latest decision on interest rates on Thursday, while the Bank of Japan, the Swiss National Bank and Brazil’s BCB will also meet this week.

Investors will also digest a wealth of economic activity data, including China’s industrial production and retail sales, UK industrial production, employment and retail sales, and producer price inflation, retail sales and US industrial production

UK GDP contracted 0.3% month-on-month in April, official figures showed on Monday, falling short of economists’ expectations for a 0.1% expansion and raising fears of an economic slowdown before Thursday’s decision from the Bank of England.

“Overall, the data series will be scrutinized for signs of a recession, with the added irony that any signs of strength in activity are likely to be a case of ‘good news’ being bad (i.e. exerting a further upward pressure on rate expectations) while the pressure on central banks is to maintain some semblance of control over rate path narratives, even though they have been proven dead wrong on inflation,” said Marc Ostwald, chief economist and global strategist at ADM Investor Services International.

What happens now with investors?

Kelly suggested that markets had become complacent in the hope that a slowdown in headline inflation was a sign that central banks had caught up with rising prices. She argued that Friday’s data indicated how far behind the Federal Reserve is and how persistent inflation is likely to be.

The US dollar strengthened once again on Monday as investors sought the traditional safe haven, sending the US dollar higher against most global currencies. Kelly noted that TD Securities is long dollar positions against the euro and Canadian dollar.

“You look at where rate hikes and prices are going, you look at stock spreads and it tells you to go long dollars,” he said.

“That’s something that’s amplifying here, and then that feeds back into the cycle of financial conditions in terms of that tightening which then goes back to the growth and to the risk side in terms of what the market wants to price in equities and credit.”

Turning to stocks, Kamal said that while there is no “perfect hedge” against inflation and recession, there are steps investors can take to weather the storm. Kleinwort Hambros continues to have a significant cash weight and is looking to implement it into fundamentally strong long-term positions when they reach “attractive prices,” he explained.

“It is undeniable that throughout this wreck there will be a lot of gems. We have increased our allocation to commodities… we may be looking to add to that, as clearly commodities is an area that is reasonably good at protecting you from inflation.” in the future”. long term,” Kamal said.

“If you’re in the stock market, it’s really hard to avoid the energy sector right now, because there’s clearly a huge structural shortage of oil and gas and energy stocks are still cheap, believe it or not, despite a run. -up, and there’s still room to run for that sector.”

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