- As the conflict in Ukraine weighs on various industries, the price of commodities, metals and energy looks set to rise
- Doubts about the US Federal Reserve’s ability to engineer a soft landing are growing amid global recession fears and stagflation risks
As the war in Ukraine adds to pressure on prices, investors could be facing a prolonged period of high inflation and may need to adjust their strategies accordingly.
The consumer price index (CPI) in the UK rose at an annual rate of 6.2% in February – the highest rate since 1992 – up from 5.5% in January1. In the eurozone, consumer prices rose by a record 5.8% in February2, while in the US, inflation reached 7.9% last month hitting new 40-year high3.
“The conflict is impacting a wide range of industries. Prices of commodities, metals and energy look like they’re only going to go one way. Further inflation is, therefore, likely. This will have a detrimental impact on consumer confidence and put further pressure on margins,” says James Rutherford, Head of European Equities at the international business of Federated Hermes.
The Bank of England warned on 17 March that CPI would rise above 8% by June and could reach double digits towards the end of the year if Russia’s invasion of Ukraine kept global energy prices at elevated levels4.
“There is no resolution in sight for the conflict, which aside from the humanitarian tragedy, means markets will have to continue to contend with elevated uncertainty, sustained commodity price rises and looming stagflationary risks,” says Silvia Dall’Angelo, Senior Economist at the international business of Federated Hermes. “The surge in energy prices means that inflation will remain higher for longer.”
Figure 1. Inflation on the rise in developed markets: US, UK and Euro consumer price indices (2002-12)
Central bank dilemma
Central banks have sought to tackle soaring inflation by raising rates. The Bank of England (BoE) hiked rates for the third time back-to-back last week while the US Fed raised its benchmark interest rate on 16 March in the first of what is expected to be a series of hikes this year.
However, Rutherford questions the market expectation that there will be rapid and significant rate rises solely because central banks are struggling to control inflation. “Rate rises usually occur when economies are growing strongly – all evidence suggests that this is not the case,” he says.
Doubts about the US Federal Reserve’s ability to engineer a soft landing are growing, Dall’Angelo says. “It will be hard for the behind-the-curve Fed to calibrate a response that succeeds in reining in inflation without hurting growth and the labour market. Bond markets have been increasingly sceptical as the differential between US two-year and ten-year yields has narrowed further to about 20bps this week.”
Equity markets rallied last week following the Fed and the BoE hikes, but have since given up some gains. The UK FTSE 100 Index closed up 0.09% on Thursday while the pan-European Eurostoxx 50 Index closed down 0.15%5.
“Faced with so many headwinds, we find it difficult to ignore the ever rising spectre of recession, and yet so far it appears equity markets do not share our concerns,” says Geir Lode, Head of Global Equities at the international business of Federated Hermes.
The Moscow Stock Exchange resumed trading of some shares on 24 March, the second stage in a phased re-opening after being suspended for a month following Russia’s invasion of Ukraine.
Trading resumed for 33 of the largest companies that make up the rouble-denominated Moex Russia Index which closed up 4.4%.
“The Moex remains about 30% down year to date as the impact of international sanctions weighs on the Russian economy. The Russian response to these sanctions is unpredictable, and the uncertainty over Russian oil supplies is contributing to an already volatile market environment,” Lode adds.