Q1 round up
Q1 took an unexpected turn when Russia invaded Ukraine. Inflation was already rising due to higher energy prices and supply chain disruptions. The start of the Russian war and Western sanctions on Moscow sent stocks tumbling and commodity prices firmly higher, boosting inflation expectations while raising questions over how quickly central banks can hike rates without tipping economies into recession.
War developments & high inflation
The key focus for the market in the second quarter will be on how the war and peace talks develop. It is impossible to know what Putin might do next; even if the war were to end sooner rather than later, the sanctions on Moscow would not be unwound immediately, meaning that energy, fuel, and food prices, the main contributors to higher inflation, will remain pressured.
Rate hikes
Higher inflation brings the prospect of more rate hikes from global central banks. The familiar slow growth, low-rate environment is transitioning to a new order which will include higher rates.
The Fed has already hiked rates in March and is expected to hike around six more times this year, with a potential 0.5% interest rate hike, which is 66% priced in for May, with another hike possible in June. They are not alone. The BoC and BoE have also raised interest rates, although the BoE is warning about how much it will be able to hike rates in H2 for fear of slowing growth. The ECB could start raising interest rates in Q3.
An easing of hostilities could mean growth still across the quarter
In short, the consequences of the Russian invasion are lower global growth, with Europe taking the largest hit and rising inflation. However, in line with some central bankers’ predictions, should hostilities ease and energy prices stabilize, modest economic growth could continue across the coming quarter, favoring equities over cash or bonds. That said, indices have already recouped a large part of their gains from the indiscriminate selling as the war started, which means further gains from here could be harder to come by. However, the fact that a 50 basis point rate hike by the Fed is still not fully priced in means that there is still some upside to be had in some areas of the markets if the Fed does hike by 0.5%.
Stocks
The higher interest rate environment is likely to favour value overgrowth. Broadly speaking, think banks, energy, and commodity stocks over high growth technology. With this in mind, we could expect the Dow to outperform the Nasdaq, despite underperforming across March and the FTSE to outperform in Europe. Looking ahead there could be a shift towards defense and security stocks as well as food and data.
FX
Central bank divergence could continue to support the USD across the second quarter against a basket of currencies. A stabilizing in hostilities could see the euro rise and record-high inflation could fuel bets of a more hawkish ECB. GBP could struggle to gain much from here in light of the more cautious outlook from the BoE. Although should the BoE point to another hike in June, then GBP could advance.
Oil
Oil prices are likely to remain elevated around the $100 per barrel mark for some time yet. This is well off the highs of $130 per barrel seen earlier in the month. The US will today decide whether to release 1 million barrels a day for the next six months. The steady drip of supply into the market should prevent oil prices from advancing back to the early March highs. It is worth keeping in mind that even if there was a cease-fire, the US and the UK are unlikely to remove sanctions on Russian oil immediately. However, a cease-fire could boost the prospect of the Iran nuclear deal being revived, as talks have currently stalled.
On the demand side of the equation, the spread of COVID in China and slowing growth in the world’s second-largest economy could hurt the demand outlook.
Gold
Gold, meanwhile, had its biggest quarterly advance in almost two years, boosted by safe-haven flows amid the ongoing war and as inflation surges. However, Gold could struggle to advance much further from here if the geopolitical situation stabilises. While Gold is a hedge against inflation, the stronger USD and expectations of a more hawkish Federal Reserve could limit the upside in the precious metal in the coming quarter. Should central banks slow down the path to monetary tightening later in the year, on fears of recession, but inflation remains elevated, Gold could rise higher.
