Following two tumultuous years, the global economy entered 2022 with what appeared to be new strength. Inflation was accelerating, but markets expected the Federal Reserve to raise its benchmark interest rate by a modest amount over the course of the year to help bring inflation down. The decision by Russia to invade Ukraine on February 24th sent shockwaves through global markets as the price of gold, wheat, crude oil, and natural gas soared. By the end of the first quarter economic momentum was waning under the weight of the Ukrainian invasion, persistent inflation, and the emergence of the Omicron variant which closed the world’s largest container port in Shanghai, among other disruptive effects.
Economic and earnings outlooks continued to weaken as the quarter progressed. As these have taken greater hold, there is greater anticipation that economic weakness will ultimately lead to a return towards price equilibrium and trend reversal in inflation. Exogenous factors in Europe complicate some of this reversal and highlight some competitive challenges, but diminished discretionary, real income should still weigh on inflation as their economies progress into 2023. With rates having moved closer towards restrictive levels, markets can start to anticipate a deceleration in central bank policy rates and, thereby, long-term, risk-free rates. Alternatively, markets will have to now look towards the potential trajectory of an economic slowdown, the impact on company cash flows, and the ability (and timing) of any future fiscal or monetary accommodation. So, we believe most of the damage from a shift away from the sustained timeframe of accommodative rate policy has occurred, and now the focus narrows to this recession’s unique impact on fundamentals for various industries and companies.