— Apr 25, 2022


Markets saw several dramatic turns of events during March. 

As widely expected, the US Federal Reserve raised interest rates for the first time since 2018. However, this was completely overshadowed by the unfolding tragedy in Ukraine following the Russian invasion.

It is worth noting that the general expectation of invasion was low. Most analysts believed an oblique non-war strategy to exert power and diminish the influence of the west was most likely. If anything this again serves as a powerful reminder of the limitations of those who forecast. 

Equity markets initially fell on Putin’s invasion. The effects of the war on the global economy have yet to be fully revealed but are likely to be profound. It seems inevitable that the invasion will add significant upwards pressure on global inflation expectations that have risen sharply over the last year.

As is widely reported, Russia albeit small in terms of contribution to the global economy of around 3-4% is influential in certain areas, predominantly those of natural resources of oil and common metals such as iron ore and aluminium but also rarer ones including nickel, palladium platinum and others.

It is the second biggest exporter of crude oil in the world and Germany specifically and Western Europe generally depends on its natural gas exports for its energy needs.

Additionally, Russia and Ukraine are called the World’s bread basket, producing nearly 30% of global wheat supply. Ukraine also produces around 75% of the world’s sunflower oil as well as a substantial share of production of the world’s fertilisers such as potash, ammonia and urea.

The recent events in Ukraine will only serve to exacerbate the already rampant inflation raging around the world and decisively shifts the balance of probabilities towards a global recession.

One has to be a supreme optimist to believe that all the added costs consumers are facing in food, energy, fuel and other household bills will not rise further and not affect their spending power.

And even more of an optimist to believe that this will not have a knock on effect on corporate profits and investment and therefore equity prices.

And yet, equity markets closed the quarter end period higher than before the Russian invasion. This seems somewhat incomprehensible. 

So why was this?

It seems that the narrative being provided by Wall Street for retail investors to continue to commit money to the markets goes along the lines of the market psychology of now expecting a recession, but betting that this will mean the Fed do not have to raise rates as much as expected.

Then once the recession becomes obvious, the Fed obligingly will turn on the taps again by launching quantitative easing,  i.e. QE5, and so flooding the markets once more with more cheap money and we will be “back to the races” as it were. 

This logic seems quite desperate and perverse to us. For one thing, as we have been reiterating for over a year now, we believe inflation will be higher and for longer and not be as easy to quell as many expect.

If so there is little chance of further QE unless the situation becomes very desperate, by which means of course asset prices will be very significantly lower. 

The Fed has also made it obvious that fighting inflation is its key objective now and they will not be bailing out markets so quickly this time, with interest rate rises coming in several early preemptive hikes.

Though we have yet to see it in equity markets, real damage has been done during the quarter in global bond markets, where the prospect of higher interest rates worldwide has meant the end of negative sovereign fixed rate bonds and general losses of around 10% or more. Such losses in a short space of time are virtually unprecedented.

The state of bond markets, war in Europe and increasing likelihood of recession seem uncomfortable bedfellows with equity markets near record highs. We will maintain our highly defensive positioning.