Our Franklin Templeton Investment Solutions team suggest broader supply disruptions that continue to hold consumer price inflation at extremely elevated levels, are key factors fueling aggressive rate hike cycles across developed markets.
Not losing sight of China
Last month inAllocation Views, we asked ourselves “where are the pain points that might trigger a wider market reaction?” With the passing of another month, in which investor caution increased, it appears that part of the trigger was simply more of the same—uncertainty about inflationary developments, policy responses, and their interaction with economic growth and corporate earnings. The ongoing war in Ukraine certainly isn’t helping these dynamics, but it seems to have moved into a phase where it is having a chronic impact on investment psychology in contrast to the acute phase, seen in early March, where it dominated everything else. Clearly, events on the ground remain shocking and tragic, but for now they do not seem to be setting the market tone directly.
They remain, however, an important driver through the lens of monetary policy. The war-related risk premium that is still present in energy prices, and the broader supply disruptions that continued to hold consumer price inflation at extremely elevated levels, are key factors fueling aggressive rate hike cycles across developed markets. A sustained march higher in US Treasury yields, close to 3% at the 10-year maturity, and renewed widening of corporate bond spreads have started to undermine the support for still elevated equity valuations. It has also resulted in an environment where any disappointment against corporate earnings estimates, or future guidance, has been punished even more severely than has become usual over recent years.
Another factor that helps to explain the weak returns in global equity markets during April was the ongoing impact of COVID-19 in China. Localized lockdowns have been extended in major cities such as Shanghai and their impact is increasingly being seen in leading indicators of activity such as purchasing managers’ indexes (see Exhibit 1), which have declined to levels not visited since the early months of the pandemic in 2020. However, it is the interplay of the highly contagious Omicron variant with the Chinese government’s zero-COVID policy that makes the situation more problematic. Rising prevalence of COVID cases in the capital of Beijing will make this balancing act even harder to manage, notwithstanding the central bank’s recent moves to stimulate the economy more broadly.
WHAT ARE THE RISKS?
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