Market week in review – The European energy crisis deepens.
September 20th 2022
In the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed the energy crisis in Europe. They also reviewed the market’s reaction to the situation, as well as the latest steps taken by global central banks to curb inflation.
UK, French inflation rates slow
Kyle opened the conversation by noting that inflationary pressures eased in parts of Europe during August, with the UK consumer price index (CPI) climbing 9.9% on a year-over-year basis, while prices in France rose by 5.9% during the same time frame. Bezrokov said that in both instances, the gains marked a slowdown from July, when inflation advanced at a 10.1% clip in the UK and at a 6.1% rate in France, respectively.
“The August inflation report in the UK, in particular, was below market consensus for a very-high reading of 10.2%,” she remarked, adding that the results from both countries suggest that inflation may have peaked in Europe. Despite this positive signal, however, Bezrokov said that indicators of economic sentiment in the region have turned extremely pessimistic – especially in Germany, where sentiment has approached all-time lows. The dour outlook can probably be chalked up to concerns around what persistently high European inflation – which the region’s energy crisis has exacerbated – might mean for the overall economy, she noted.
August CPI report triggers market selloff
Turning to the U.S., Kyle and Bezrokov homed in on the August CPI report, which led to a significant selloff in markets when the Labour Department released it on 13 September. Investors appeared to be particularly unnerved by a higher-than-expected increase in the core CPI, which strips out prices from the more-volatile energy and food sectors, Bezrokov explained.
“The rise in prices for services, including shelter, continued unabated during August, and actually surprised to the upside,” she remarked, noting that the core CPI increased 0.6% during August, versus expectations for a 0.4% rise. Bezrokov said that 60% of categories in the CPI saw price increases last month, suggesting that U.S. inflation is both persistent and broad. She added that core producer-price index (PPI) data released the following day did little to alleviate concerns that inflation is becoming more entrenched in the economy, with numbers surprising to the upside.
All in all, the recent reports helped unleash significant volatility in markets the week of 12 September, Bezrokov said, noting that this is common during times of tremendous uncertainty. “It’s important to realise that markets tend to be forward-looking, which means they’re pricing in not only what’s happening now, but also expectations for the future. And right now, there is a range of potential scenarios depicting how things could unfold as it pertains to inflation and U.S. Federal Reserve (Fed) policy,” Bezrokov explained, emphasising that each scenario has a decent probability of occurring.
Where are recession risks increasing the most?
Kyle and Bezrokov wrapped up the segment with a look at how the latest inflation numbers are likely to impact the Fed’s rate-hiking campaign. Bezrokov said the August CPI report suggests that the U.S. central bank is likely to continue on its path of aggressive interest-rate increases, with most traders pricing in a third-consecutive 75-basis-point increase at the upcoming 20-21 September, Fed meeting.
Bezrokov said that earlier in the summer, markets were factoring in the potential for a dovish Fed pivot – should there be a material hit to U.S. growth expectations – but with inflation continuing to run hot and potentially becoming more entrenched, they’ve recently returned to pricing in a more hawkish Fed policy.
“Importantly, a more aggressive U.S. central bank raises the chances of a Fed mistake – which in turn means that the probabilities of a recession in the U.S. are also rising,” Bezrokov remarked. She emphasised, however, that the U.S. economy is on more solid footing compared to other parts of the world, such as Europe, where the ongoing impacts of the Russia-Ukraine war have heightened recessionary risks.
In addition, Bezrokov said that although the recent moves in markets have been dramatic, she and the team of Russell Investments strategists aren’t currently seeing strong signs of panic across all asset classes. She also noted that there hasn’t been a significant rise in default rates and that overall, the repricing in markets is normal given the high degree of uncertainty.
“Ultimately, the key takeaway here is that in times of great uncertainty, having a thoughtful strategic asset allocation in place – and sticking to it, despite behavioural bias – is probably one of the most useful things an investor can do,” Bezrokov concluded.
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Source: Russel Investments
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