Weekly review 11 April 2022: Is a recession looming or is it a false alarm?


What does the Fed’s tightening monetary policy mean for the markets? When will the ECB’s monetary policy follow in the Fed’s footsteps? What additional sanctions will be imposed on Russia this week? Are Europe and the USA sliding towards a recession?

What were last week’s key market events?

Last week, we monitored the continued brisk rise in interest rates in both Europe and the United States. The US central bank is expected to continue tightening its monetary policy, and in Europe, the ECB’s rhetoric suggests upcoming measures.

The USA and the EU both increased the sanctions imposed on Russia, isolating the country even further from the international payment systems.

Last week was relatively subdued in the equity markets.

The war in Ukraine continues. What impact will the additional sanctions imposed on Russia have on the markets?

Last week, both the USA and Europe decided to impose additional sanctions on Russia due to its continuing assault on Ukraine.

The USA imposed sanctions on new banks, expelling them from the SWIFT system. The sanctions mean that Russia can no longer use its frozen dollar assets to pay interest or make payments on its sovereign debt, which forced Russia to pay its dollar-denominated government bonds’ coupon rates in roubles. As the debt was due in dollars, the credit ratings agency Standard & Poor’s downgraded Russia’s credit rating to “selective default”, i.e. partial default.

The EU also decided to impose further sanctions on Russia; imports of Russian coal to Europe were prohibited with a transitional period of four months. Coal imports only make up a relatively small proportion of Russia’s total energy and overall exports, and oil and gas, which are harder to replace from Europe’s perspective, have yet to be put on the negotiating table. However, the European Commission seems to be preparing a proposal to restrict oil imports.

This week we will receive new inflation figures from the USA. What are the markets’ expectations with regard to the figures?

Inflation remains high both in Europe and across the Atlantic. The United States’ precise inflation figures for March will be released on 12 April. The figures are expected to be high, especially for energy. In addition, the USA will also release retail sales figures and consumer confidence figures this week. Particularly noteworthy is whether the dramatic rise in the price of energy has impacted retail demand and consumer confidence. Typically, inflation experienced by energy and other essential products affects retail demand as the assets available to consumers dwindle.

What measures can we expect from the Fed as a reaction to the inflation?

If the inflation continues, the Fed is expected to tighten its monetary policy even further. The minutes of the Fed’s March meeting, which were released last Wednesday, reveal that US monetary policy can be expected to tighten even more this year than was presumed; many on the Fed’s Board were in favour of steeper interest rate hikes already at the start of March. Monetary policy is expected to be tightened in two ways: with key interest rate hikes and by shrinking the central bank’s balance sheet.

What about the European Central Bank?

The ECB will hold its interest rate meeting on 14 April. The ECB is not expected to make any changes to its monetary policy in its meeting, but the markets are waiting to hear when the next key interest rate hike might happen. Earlier, the expectation was that the key interest rate would not be raised until at the end of the year, but now it seems that the hike could happen already in the autumn or even in the summer. The timing of the interest rate hike will be a key item on the meeting agenda. A lot of attention will focus on ECB President Christine Lagarde’s statement at the post-meeting press conference.

Recent signs indicate slowing economic growth. Are we facing a recession?

In addition to the rise in interest rates in the USA and Europe and the new Russia sanctions, China is suffering from an accelerating wave of Covid-19, causing full lockdowns to be imposed on several major cities. The interest rate differential between the US 10-year government bond and the 2-year government bond, which is generally considered a good indicator, fell to zero, which has typically happened 12–18 months before a recession. There are, however, contradictory signs: the interest rate differential between the 10-year government bond and 3-month bond has respectively grown. The euro zone’s corresponding interest rate differential has also grown recently.

We must also bear in mind that the explanatory power of individual indicators, such as interest rate differentials, is limited. The interest rate differential has historically fallen to zero without a downturn hitting the real economy. There is reason to remain sceptical of the signals from individual indicators, especially in these exceptional times. The continuing pandemic and the war mean that the market situation is unpredictable and indicators that have previously proven useful may not apply in the same way as in a normal situation.

How is the current uncertainty reflected in the equity and fixed income markets?

Recently, the equity markets have shown strong performance, especially in the sectors and areas affected the most at the initial stages of the war in Ukraine. These include the Nordic and European markets in particular, both of which reacted dramatically to the Russian attack. The emerging markets, on the other hand, barely fell at all due to the war, but they have fallen over the past few weeks, partly due to China’s economic difficulties.

Another indication of the unusualness of the current situation is the good performance of sectors and stocks that earlier reacted negatively to rising interest rates, despite the upward interest rate trend. Last week’s best performers were the stable sectors, while a decline occurred in technology stocks, for example.

On the fixed income markets, the rise in interest rates has depressed returns on fixed income investments across the board, but especially in longer-term fixed income investments, such as government bonds. Spreads, which widened due to the war in Ukraine, have also impacted returns negatively. Nevertheless, the return expectation for new investments has risen, thanks to the rise in interest rates and widening of spreads.

Next week, the weekly review will be on Easter break.


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