The war in Ukraine is still the focus of the markets. What does the situation look like right now?
The war in Ukraine is still the focus of the European markets in particular. Market reactions to the events have clearly declined, however, and many stock markets have returned to their pre-war levels. Nevertheless, the war may continue to cause significant market turbulence.
A major question for the economy and markets is whether efforts will be made to hasten the ending of Europe’s dependence on Russian energy.
What factors are currently driving inflation?
In early 2022, inflation was expected to slow down by the summer at the latest as logistics and production challenges eased. However, these hopes were dashed with the rising raw material prices resulting from the war in Ukraine. Now, the predicted return to anywhere near the central banks’ 2% inflation target rate seems unlikely this year.
The war in Ukraine raised commodity prices across the board. Russia has global significance as an oil and gas producer, and the current and possible future sanctions and supply challenges have raised energy prices extensively, in Europe in particular. In addition to energy prices, the prices of several metals and wheat have risen since the war started.
More pressure for prices to rise has come from China where the Covid-19 situation has begun escalating dramatically, and the resulting lockdowns impact both production and logistics.
Is there an end in sight for inflation acceleration?
Inflation is expected to fall as production and logistics challenges abate and raw material prices settle. In the longer term, the rise in prices, especially in the USA, will raise inflation pressures. Also, it is likely that production will be brought closer to the consumer due to the global production chain challenges and geopolitics, which will raise prices and thus also inflation.
The markets are pricing in a settling down of inflation within the space of a couple of years. The risk that inflation will play a much more central role in the development of the entire economy has risen, however.
What kind of interest rate hikes are expected from the Fed and ECB now?
In the USA, interest rates were raised once already, and several more hikes are expected before the end of the year. It is also possible that interest rates would be raised by 0.5% instead of the usual 0.25% at a time at one or more meetings.
In Europe, an interest rate hike is expected to occur in the autumn. Bond purchase programmes are being wound down for the second quarter running.
Although interest rates are rising rapidly, central banks will not raise interest rates forever, Europe being even more careful. For example, the 12-month Euribor is priced in as rising to one and a half per cent and then settling. In the longer term, interest rates are expected to fall again.
Economic growth will slow, but how much? Could we be facing an economic collapse?
Expectations for economic growth in 2022 were strong in Europe especially, where the lifting of Covid restrictions was predicted to clearly accelerate growth. However, the cloud of war in Ukraine overshadowed the growth, and the size of the cloud is difficult to judge. After the start of the war, expectations for global growth have clearly been reduced to a more moderate level. The greatest blow will likely be to Europe. China, on the other hand, is at a recovery phase of the economic cycle.
The rise in raw material prices and availability challenges caused by economic sanctions are reflected on growth in many ways. Especially in Europe, economic growth will suffer from the imposed sanctions, especially when it comes to energy. If, as a countermeasure to Russia’s actions in Ukraine, the import of energy from Russia to Europe is radically reduced or ended fully, the impacts on Europe’s economy will also be dramatic.
As a consequence of rising prices, companies’ production costs are rising and consumers’ confidence and spending opportunities are weakening. In addition, a tightening monetary policy will weaken financing conditions. Rising interest rates, widening spreads and falling stocks are serving to curb companies’ investment appetite, among other things.
It may be that we are facing a technical depression, where, instead of growing, the economy shrinks in two consecutive quarters. The basis remains good, however, and a collapse still looks unlikely. Many questions still abound when it comes to the economy and economic growth is difficult to predict accurately.
What do the economy and markets look like in the short and long term?
Short term (<1 year)
Long term (1–5 years)
What has been happening on the equity markets recently?
The year has been relatively volatile on the equity markets. When the war began in March, equity indices were, at their lowest, 10–20 % lower than at the start of the year. Finland had a worse time than the rest of Europe, and has not recovered in line with the rest of the world. The USA, on which the Ukraine crisis has had less of a direct impact, has been the best-performing market.
Following last year’s success, this year the emerging markets have been left behind. The war in Ukraine is not the only reason, however. The poor return on China’s market is depressing the return on the entire market.
The sector rotation that occurred in the first part of the year, with technology sector shares sold and cyclical shares bought, has now settled somewhat and slightly turned around also. Retail investors who abandoned the markets momentarily have come back with a vengeance in recent weeks.
And what about the fixed income markets?
The fixed income markets have been on a downward trajectory all year, more or less. A short rise was seen at the start of the war due to demand for safe havens, when interest rates fell and government bonds rose over a few days. After that, the fixed income markets’ downhill has continued.
The past three months have been one of the weakest quarters in a long while. In particular, government bond investors’ real returns have been low in recent years due to the low interest rate level, and now they have lost several years’ returns within a brief period.
The widening of spreads has eaten into corporate bond investors’ returns, especially since the war began. At the moment, returns have slightly recovered.
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