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T&IO Weekly Market Updates

5 minutes read
Last updated on 14th Jan 2022

 

Market and Economic review 

 

Firstly, welcome to the first weekly of 2022 and thank you for your continued readership.

2022 continued in a similar vein to 2021, in terms of the markets’ laser-like focus on inflation. On Wednesday the US Consumer Price Index (CPI) revealed a 7.0% YoY increase to December, the largest print since 1982. The increase aligned with expectations and core inflation (which removes volatile items, including food and energy), registered a 5.5% increase. Several factors drove the increase in CPI year-on-year. Components that were thought to be transitory due to the lockdowns and supply chain shortages such as travel, used cars and energy, stayed elevated throughout the year. Other large components of the basket have started to play catch up, such as shelter, due to higher home prices, low vacancy rates and a rebound in rents.

After front running the US inflation numbers, where the 10-year treasury bond rose by almost 30 basis points, rates cooled and dropped by 7 basis points after digesting the data release. Risk assets performed accordingly, where a tepid start to year, due to the increase in rates, was met with a rally as bond yields fell; developed markets were up by 0.47% and emerging markets 3% week on week. The strong performance in emerging markets was chiefly aided by the sharply weakening dollar, as the currency markets seemed to take issue with the US CPI number, in contrast to the bond and equity markets which were more sanguine in their response. Markets have started adjusting their expectations for the path of policy rates and monetary accommodation, and Fed Chair Jerome Powell hopes that by communicating the direction of travel (clearly sign posting changes in QE), he can avoid the taper tantrum that was experienced in 2013. The key question that will be tested throughout the year is whether the Federal Reserve’s actions bring inflation under control or if they will have to raise interest rates faster and harder should inflation expectations remain stubbornly high. Powell stated he wasn’t even thinking about thinking raising rates in June 2020, however today rate rises, tapering, and balance sheet reduction are all tools that have been mentioned to manage the ‘non-transitory’ inflation problem. Some commentators, argue that we have likely experienced a peak and therefore the subsequent decline in inflation should help the central bank in its response. With profit growth still robust across many sectors and regions, MAPM view the reaction function of the biggest central bank in the world as key in determining whether headwinds of monetary tightening outweigh equity market fundamentals.

Another heavyweight that reported inflation this week was China, where the rate fell to 1.5% year-on-year to December from 2.3% the previous month. This was primarily due to a fall in food prices after efforts were made to shore up supply after disruptions caused by bad weather and a fall in pork prices. The disruption to demand due to Omicron-linked lockdown measures experienced on the mainland also contributed to weaker price increases. As a result of this weakness, lockdowns and the fallout from the Evergrande property crisis, the central bank has a lot more freedom to implement stimulus and they have made tentative steps in this regard, with measures targeted at lifting confidence in the property sector by minimising red tape on mortgage approvals, reducing loan quotas, and lowering the reserve requirement ratio for banks. We believe they have scope to do more, which is in direct contrast to the tightening bias seen in the West.

UK GDP rose by 8% for the year to November compared to 5.1% the prior month and beating expectations of 7.5%. The strong growth now means that the UK economy has surpassed the pre-pandemic level of GDP, however economists predict an Omicron led contraction in December and January.

Data collected by the Copernicus Climate Change Service (CS3) in 2021 revealed a rapid increase in carbon dioxide and methane emissions in the atmosphere. A global race to lower emissions has proven to be unsuccessful as global temperatures continue to rise. It was reported by CS3 that the last seven consecutive years have been the warmest on record, making the target of limiting global warming to below 1.5°C look more ambitious than ever. Since COP26 many pledges have been made including the Global Methane Pledge, which gathered 105 countries to pledge to reduce methane emissions by 30% by 2030. A consequence of climate change is more frequent extreme weather events, which have been linked to commodity price spikes through damaged crops and frequent shortages. Extreme weather behaviour patterns were displayed in various regions over the year such as Canada, where unprecedented heatwaves and droughts in July caused the price of yellow peas used as a protein substitute in plant based foods to increase by 80%. During the summer, floods experienced in Europe triggered a 180% increase in the price of Belgian potatoes . A lack of food security and price stability are one of the reasons for the Arab Spring uprising last decade, so the knock affects are not just economic, but political and social.

Amongst economic data out next week, we have inflation numbers from the EU and the UK, which may be a good indicator on whether the rate of price increases are global or more focussed in the US, Chinese GDP, the Bank of Japan interest rate decision, as well as flash PMIs for the US and Eurozone.

Tactical review & outlook

After a tepid start for equities this year, we took the opportunity to incrementally increase our exposure to the asset class by diversifying into the UK and Europe, funded by the cheapest asset in the portfolio: European credit. We maintain a diversifying overweight to Alternatives and overweight position in US equities, such that the ratio of the equity overweight is 50% US, 25% UK and 25% European equity. We continue to view the underlying macro backdrop as supportive for risk assets and acknowledge central banks’ strong motivation to support economic growth momentum whilst normalising policy from its emergency settings. High inflation, and the risk of it getting out of control, creates a tough balancing act, and several central banks have taken steps to address this risk in a managed way. Rising Omicron cases represent a possible headwind, particularly in Asia, though data so far indicates that the existing crop of vaccines should be sufficient to bring it under control. We will continue to monitor the evolving situation carefully and watch for both opportunities and threats to our positioning.

Dean Cook

T&IO Weekly Market Update Podcast

Dean Cook, Portfolio Analyst in the Multi Asset Portfolio Management Team at T&IO talks through this week’s latest market developments and T&IO’s current outlook.

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