JAKARTA, Apr 26 (Bloomberg): The inflation scare that’s dominated much of the investment backdrop this year keeps finding new ways to send shockwaves through markets.
On Monday, investors awoke to the idea of China locking down Beijing -- a city of more than 20 million people -- adding to worries about supply stresses that are keeping the heat on prices. European stocks fell the most since April 6, and U.S. futures are pointing to a grim open.
A rush for the safety of havens saw US Treasuries, European bonds and the dollar all rally.
"Inflation is definitely front and center of investors’ concern, and of course the China story feeds further into that inflation pressure because China is the mother of all supply chains,” said Janet Mui, head of market analysis at Brewin Dolphin.
"That concern is intensifying across the board, whether you are talking about the goods side or the services side.”
The inflation flare-up, along with the increasingly aggressive response of central banks, is already taking a toll on demand, spending and corporate earnings. Russia’s invasion of Ukraine has compounded concerns about both price pressures and economic growth, with some seeing a danger of a bout of stagflation.
It’s a toxic combination for markets, with stocks, bonds and currencies all taking their cue from a price spike that many once hoped would be transitory, but is proving to be much more damaging to households and companies.
In the U.S., the S&P 500 Index has slumped for three weeks in a row, sinking to the lowest level since mid-March on Friday. It appears ready to join the ongoing bear market, Morgan Stanley’s Michael J. Wilson warned in a note Monday.
Recession Risk
Amid the inflation danger, monetary authorities are now racing to respond, pulling their emergency Covid stimulus and increasing interest rates to fight the fire.
Bond markets are also well advanced in pricing the massive policy shift underway, acknowledging that more than a decade of ultra-easy money is on the way out. Negative yields have vanished from the corporate bond market, according to a Bloomberg index. That’s a massive turnaround from August, when more than $1.5 trillion of debt came with a sub-zero yield.
The latest inflation concerns come hot on the heels of tough talk late last week from Federal Reserve Chair Jerome Powell, who endorsed the idea of "front-loading” monetary policy tightening. The European Central Bank could start raising interest rates as soon as the summer, and the euro area’s negative-rate era could be gone by the end of 2022.
That’s left investors assessing the risk of a European or U.S. recession as soon as next year. Such concerns have been highlighted by the International Monetary Fund, which has slashed its world growth forecast by the most since the early months of the Covid-19 pandemic, and projected even faster inflation.
Global expansion will slow to 3.6% in 2022, it said last week, down from a forecast of 4.4% before the war.
Neil Shearing at Capital Economics says the market narrative for the post-Covid period has flipped from "Roaring Twenties” to "Recessionary Twenties,” though he cautions that reality is likely to be more complicated than that blunt idea.
"The risk of further disruption of the Chinese economy means the stagflation impulse for the US, EU economies is greater, and therefore means the Fed, ECB etc. stay on aggressive tightening paths -- perhaps even more aggressive, following the lockdown -- but that they do this into an even softer growth environment,” said Peter Chatwell, a strategist at Mizuho International Plc. "This is extremely challenging for equity valuations.”
European Stocks Extend Slump as China, Fed Spark Risk-Off Mood
On the inflation front, China’s Covid lockdowns may offer some relief. Expectations of weaker Chinese demand pushed oil and other commodities lower on Monday, which will help ease cost pressures squeezing economies. Brent dropped 4.4%, falling back below $102 a barrel.
But signs of caution, even fear, are widespread across asset classes. Measures of European credit risk rose on Monday to their highest since early March. Many investors have already started paring their exposure to junk bonds, seeking refuge in better-rated notes due to concerns over the weakest companies’ ability to weather a downturn.
Even Emmanuel Macron’s election victory in Sunday’s French presidential election failed to provide a boost to stocks at the start of the week, despite predictions that his defeat of Marine Le Pen would provide relief to investors. France’s benchmark CAC 40 fell 2.3%, and the euro also weakened amid dollar demand.
"In a risk-off environment, bad news gets priced very badly and good news is ignored,” Virginie Maisonneuve, global chief investment officer for equities at Allianz Global Investors, told Bloomberg Television. "It’s like, check on the list and move on.” - Bloomberg
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