Hawks and doves
Central banks remain on high alert as pricing pressures across the world remain elevated. US inflation for May surprised to the upside at 8,6%, pulling the rug from under investors that saw March to be the peak in inflation. This in turn weighed on consumer confidence, with the preliminary University of Michigan consumer sentiment index for July reaching an all-time low of 50,2 points, while inflation expectations for the 12 months ahead also ratcheted up. This laid the foundation for a 75 bps interest rate hike from the US Federal Reserve (Fed), the largest hike since 1994. While forward guidance from the Fed is currently taken with a pinch of salt, Chair Jerome Powell indicated a preference to bring inflation under control, even at the expense of growth, further driving recessionary fears.

The European Central Bank (ECB) kept policy rates unchanged but used the June meeting to communicate a decidedly hawkish pivot, indicating that it would end its bond-buying programme in July and start its policy rate hiking cycle the same month with 25 bps, with the possibility of more aggressive actions should the inflation outlook deteriorate. European government bond yields rose on the news, with the yield on the 10-year German bund breaching 1,7%, a high since 2014. More concerning to policy makers, however, was the spike in bond yields of peripheral countries such as Italy, relative to German bond yields, with the spread between these two reaching its highest levels since 2013. Seen as a key measure of financial stress in Europe, the ECB responded with an emergency meeting and a pledge to address the divergence in borrowing cost with a new ‘anti-fragmentation instrument’, details of which have not yet been revealed.
 

Markets had a brutal month, quarter and first half of 2022, with the latter being one of the worst six-month periods since the 1970s, as the US 10-year bond yield increased by about 150 bps since the start of the year and tighter financial conditions took hold. The S&P 500 dipped into official bear market territory several times in, ending the quarter down by 16,1% and bringing the first half number to -20,0%. The technology-heavy Nasdaq 100 fared even worse, losing 29,2% in the first six months of 2022. European indices slumped on higher inflation prints and higher vulnerability to recession given the ongoing Russia-Ukraine war, which was further emphasised as Russia decreased supply of natural gas to Europe in the month. Chinese activity gauges, while still on the weak side, appear to be stabilising, as cities such as Shanghai and Beijing ease lockdown restrictions. Improved mobility and a recommitment from President Xi Jinping to the 5,5% growth target helped the Hang Seng Index gain 3,0% over the month, although the zero-tolerance approach to Covid-19 is likely to remain in place. The USD stands out as one of the main beneficiaries of the current environment, having appreciated by 9,1% on a trade-weighted basis this year. Global bond market volatility remained elevated as the US 10-year bond yield peaked at close to 3,5%, before giving way into month-end. In US dollar terms, the Bloomberg Global Aggregate Bond Index declined by 8,3% in the second quarter and by 13,9% year to date.

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