Things can change very quickly in financial markets these days. Only last summer most G20 central banks were still in emergency pandemic easing mode, more worried about Covid risks and economic recoveries than the threat of rising inflation that was deemed ‘transient’. Both the US Federal Reserve (“the Fed”) and markets held a benign outlook for inflation and a sanguine stance for accommodative financial conditions, pricing in a slow tapering of the Fed’s quantitative easing programme this year and no rate hikes until 2024. Now, it seems the debate has moved to 3-5 rate hikes and quantitative tightening in 2022!

Most of this re-pricing has occurred over the last three months with the 1-Year US Treasury Bond yield rising a staggering 65 basis points from 0.12%at the end of October to 0.77% at the end of January. With the recognition of growing inflation pressures becoming more persistent, and the abandonment of the mantra that rising consumer prices were merely a temporary cyclical spike above its mandated 2% target level, the Fed has laid the grounds for a series of rate hikes starting in March, completing its hawkish (albeit rushed and disorderly) pivot. Joining them has been the Bank of England, who announced this month a second consecutive increase to its Bank Rate by 25 basis points to 0.5%, marking the first back-to-back rate hike for the Bank since 2004 and hinting there’s more to come in 2022. However, the biggest shock to markets and investors came just last week, the European Central Bank’s President Lagarde brought the prospect of higher Euro interest rates into view for the first time since 2011, noting “unanimous concern” about upward inflation surprises and not repeating her previous remarks that a 2022 rate hike was unlikely. This was almost unfathomable only a few weeks ago.

All of this has translated into turbulence in financial markets, but whilst most participants have long been prepared for volatility in the fixed income markets, it’s the turbulence in the equity markets that have got investors asking questions about the resilience of the mighty US bull market. After all, 2022 has already seen many global equity indices drop between 5-10%, and also the biggest drop in market capitalisation of any stock in history with Meta declining -26% in one day, wiping out an eye-watering $237bn in value. Whilst concerning, all is not doom and gloom. A closer look at the last 30 years of US equity returns amidst 4 Fed rate hiking cycles reveals that equities have generated positive returns in each hiking cycle, albeit with a lower average return, but most interestingly without any significant drawdowns akin to previous crisis events.

The economy is decelerating from its unprecedented pandemic recovery speed but is still expected to expand at roughly twice the pace of its long-term average growth rate in 2022. Wage and employment cost growth have also accelerated to the highest levels in the post-Global Financial Crisis era. The labour force participation rate continues to rise slowly but is still notably below its pre-pandemic level, despite nearly 2 million young workers entering the workforce. The Fed is expected to raise interest rates between 4-7 times this year and start reducing the size of its balance sheet.

The economy slowed down late last year on the back of supply disruptions and covid restrictions and is facing two contradictory forces in 2022: a strong job market and unspent accumulated savings, versus elevated inflation levels. Consumer sentiment remains resilient relative to other regions and savings should provide a meaningful buffer. The largest inflation component is energy which should stabilise this year, albeit remain expensive. Geopolitical risks remain as Russian military forces build on Ukraine’s borders despite calls from NATO to deescalate and desist.

The IMF expects the UK to grow the fastest in the industrialised G7 economic bloc this year but surging inflation and energy bills, and higher taxes, are expected to hurt disposable household incomes and may cause a cost-of-living crisis, potentially taking the steam out of the economic recovery. The BOE announced its second consecutive interest rate increase, the first time it’s done back-to-back hikes since 2004.

Japan’s economic recovery still lags behind other major economies but is catching up and helped by a recently announced large fiscal stimulus package from newly elected Prime Minister Kishida. Headline consumer price inflation has accelerated to above long-term levels and is gathering momentum, but core inflation excluding food & energy prices has fallen back deeper into deflationary territory indicating that most of Japan’s inflation has been imported.

The economic growth slowdown is moderating as the credit and aggregate financing cycle is bottoming and tax cuts are being implemented. Infrastructure investment rising and the property sector liquidity is easing. The Winter Olympics is under way and the highly significant 20th Communist Party Congress is due this year. The People’s Bank of China is the only major central bank that has cut interest rates and eased financial conditions this year.

Despite a buoyant global economic recovery in 2021, the BRITS economies are still expected to grow at an even pace this year relative to their developed market counterparts in the US and Europe where policy support has been greater.

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