In this article, we discuss the current economic and monetary policy environment. What does it all mean for the markets and where are stocks, commodities and currencies headed from here?
- Inflation is the root cause of all volatility
- Rising interest rates will keep stocks under pressure
- Crude oil and copper hurt as commodities weighed down by demand concerns
- Watch out for commodity dollars
- Japanese yen remains weakest link in FX
Inflation, inflation and inflation
As we head towards the end of the second quarter, sentiment towards stocks, cryptos and many other risk-sensitive assets continue to remain negative. There are many reasons for this, but it all boils down to high inflation around the world, which is hurting economic activity and causing major central banks to proceed with aggressive rate hikes at the same time. Indeed, the latest CPI data from the UK on Wednesday showed consumer prices raced to a fresh 40-year high of 9.1% in the 12 months to May as prices of bread, cereals and meat rose further amid ongoing supply troubles because of the Ukraine-Russia war. The combination of weak growth and surging inflation around the world has raised concerns over stagflation while also unnerving bond markets. Yields on debts of peripheral Eurozone countries in particular is an area of concern, although the ECB has tried to address the problem. It remains to be seen whether they will be successful now that the central bank has ended bond buying and promised to raise interest rates starting in July.
Rising interest rates will keep stocks under pressure
This chart tells you all you need to know why low-div-yielding growth stocks in particular have been declining for months now:
In an environment of rising interest rates, it is difficult to see why yields would stop rising until the hiking cycle ends, or we are very close to that time. As such, I continue to expect more pain for bond and stock prices. It is a bear market.
Commodities: Crude oil and copper extend declines
Commodities such as Iron ore, copper and crude oil have fallen sharply in recent days and more losses could be on the way. That’s because demand concerns are on the rise due to growing expectations that the global economy is heading for a sharp slowdown in the coming months, with China – a major importer of commodities – being a major source for concern. Unlike the rest of the world, China, the world’s second largest economy, has been unable to put coronavirus behind it. As a result, it has been going into repeated lockdowns, which has had ramifications in all areas of its economy, not least the property market. This is reducing demand for metals such as copper and iron, used in the construction industry.
Globally, consumers’ disposable incomes have fallen sharply because of the big rise in inflation, hurting some emerging markets particularly badly. It is possible that the slowdown will be more severe than expected, and that’s what investors are worried about the most. If you look at recent price action across asset classes – from stocks to cryptos – they are all pointing to the same thing.
Brent crude oil has now broken its bullish trend line, which could pave the way for more technical selling pressure in the days to come:
Another commodity to keep an eye on is copper, which has been falling on demand concerns. It is stuck inside a bearish channel, so we are continuing to look to fade rallies into resistance and expect support levels to break down.
Watch out for commodity dollars
With commodity prices tumbling, this is going to pressurise commodity dollars such as the Australian, New Zealand and Canadian dollars. The USD/CAD appears to have created a base near 1.29 handle and it is now poised to break out above the 1.30 handle. Will it be successful?
Japanese yen remains weakest link in FX
Despite the fact the markets have been in a general risk-off environment, investors continue to dump the perceived safe-haven Japanese yen. The yen has been under renewed selling pressure ever since Friday, when the Bank of Japan refused to alter its monetary policy setting, even though there were signs it was becoming difficult and unjustifiable for it to remain the sole central bank still trying to suppress yields. Indeed, we and many other analysts had thought it was time for it to join the global battle against inflation, like the SNB did on Thursday of last week and others have done previously. But no, the BOJ decided to keep its current monetary policy stance unchanged, and this caused the yen to give up all the gains it had made over the past several days in anticipation of a surprise, and some. Indeed, by Tuesday, the USD/JPY raced to a fresh 24-year high as the yen continued to slide against all major currencies.
It looks like the Japanese central bank is more concerned about growth than inflation overshooting. The weaker yen will certainly raise inflation further in Japan, but it will make its exports attractive for foreign buyers. Going forward, there is the potential we will see some form of government intervention if the yen weakens significantly further. In the slightly longer-term outlook, interest rates will probably rise in Japan anyway. A weak currency means Japan will continue to import inflation, especially as oil prices remain elevated after they skyrocketed in the past few months. If price pressures were to rise further because of the exchange rate remaining weak for a prolonged period, then eventually the BoJ will have to tighten its belt more aggressively. But the trend is well established and until that changes, we don’t want to fight it.