• April 4th, 2022
• By Midsilver Investment Limited

Before the sudden rise in geopolitical tensions introduced fresh uncertainty, financial markets were already reeling from indications of a faster global monetary policy tightening. During the observed period, there was a noticeable rise in government bond yields. Equity markets declined, with investors shifting from technology and growth-centric stocks to value stocks. Corporate credit spreads remained comparatively stable. Non-Asian emerging market economies (EMEs) experienced moderate financial tightening.

Global inflationary pressures ramped up in the three months ending 21 February, even as the effects of the Omicron variant diminished rapidly. Despite gold's stagnant performance, traditionally seen as an inflation buffer, escalating energy commodity prices and ongoing supply chain disruptions significantly influenced the heightened inflation rates.

Investors grew increasingly wary of an aggressive global monetary policy tightening. By mid-December, nominal bond yields in most advanced economies (AEs) started rising, largely influenced by the growing consensus regarding the Federal Reserve's stance. This rise was primarily attributed to a spike in real yields, while inflation expectations remained unchanged. Still, real (adjusted for inflation) yields were predominantly negative. In the US, rate increases predominantly affected the shorter end of the yield curve, making it flatter compared to other AEs' term structures. The dollar gained strength against AE currencies, especially those from central banks lagging in the tightening process. In Europe, the divergent tightening guidance from the Fed and the ECB widened the gap between peripheral and bund spreads.

This monetary policy transition had pronounced effects on high-risk assets. Global stock markets faced challenges at the outset of 2022. Tech stocks, which are perceived as more vulnerable to interest rate shifts, encountered significant valuation drops in January, as investors pivoted to energy and value stocks. Interestingly, the overall corporate spreads expanded only slightly, even contracting for sectors initially impacted by the emergence of Omicron. Credit spreads, mirroring equities, displayed a similar shift from tech to energy and value.

For EMEs, financial conditions varied but remained largely steady. Yields in local currencies rose more at the shorter end, especially in non-Asian nations. Dollar-denominated debt spreads exhibited a moderate increase across the spectrum. In China, the central bank incrementally offered support, as economic challenges persisted due to the real estate sector and a fresh Covid-19 outbreak. Exchange rates relative to the US dollar remained unchanged, barring Latin American currencies, which saw notable appreciation. Investment flows into Asian EMEs regained strength, fostering looser financial conditions compared to other EMEs.