Global financial markets continue to exhibit increased volatility, as central banks’ guidance points to significantly higher policy interest rates from current levels, in order to combat inflation. Stress in global financial markets are above average levels, according to the US Treasury OFR Financial Stress Index.
Discounting rising probabilities for a “hard landing”, the S&P500 has decreased by -17% since its January highs of 4797, dipping briefly into “bear market” territory on Friday.
The US Dollar lost ground after having reached a 20-year high in trade-weighted terms (DXY index -1.4% wow and a further -1% on Monday), as the decline in Bond yields more than offsets investors’ elevated “safe haven” demand. Two-year interest rate differentials (Germany versus US) narrowed by 23 bps to 222 bps. The USD tends to benefit both when the US economy overperforms rest-of-the world economic growth, but also, counter-intuitively, during recessions, as demand for safe-assets picks up.
Sustained geopolitical tensions add to market volatility. US President Biden’s comments that the US will intervene militarily if China tries to take control of (the self-governing) Taiwan by force, drew attention. Having said that, Mr. Biden reiterated the US’s agreement with the “One China” policy, under which the US acknowledges that Taiwan is part of China.
The economic background in China remains bleak, as well. House prices lost further ground in April, in view of soft demand combined with pandemic-related restrictions weighing on transactions. In the 70 medium and large-sized cities monitored by China’s Bureau of Statistics, the annual growth for new residential buildings stood at +0.7% year-over-year (on a population-weighted average basis), the lowest since October 2015, from a peak of +11% yoy during 2019.
Regarding euro area data, PMIs for May maintained an outlook of strong growth in services (56.3), in view of tourism and recreation activities getting a boost from pandemic-related pent-up demand. On the other hand, manufacturing output struggled to grow (51.2) due to headwinds from supply chain jitters. Overall, the composite PMI was down by 0.9 pts to 54.9 in May.
The European Commission downgraded sharply its GDP forecasts for the euro area compared with three months ago, by 1.3 pps to +2.7% for 2022 and by 0.4 pps to +2.3% in 2023, from +5.4% in 2021. That development is mainly due to the war in Ukraine, leading to supply disruptions, uncertainty and renewed inflation pressures which squeeze households’ purchasing power and accelerate the tightening of financial conditions. The balance of risks is heavily skewed to the downside.
The still strong headline forecast for 2022 masks a subdued growth dynamic. Indeed, the biggest portion (1.9 pps) is the result of carry-over effects from the previous year (or, in other words, the mechanical effect if the quarterly levels of GDP remained at the same level as those in Q4:2021), with 0.8 pps attributed to growth within 2022. According to our estimates, full-year 2022 expectations are boosted mechanically in the US, as well.