The next speed bump

Two years into the corona pandemic, which saw an unprecedented global monetary and fiscal stimulus and a disruption of global supply chains, not all major economies have recovered from the aftermath. We are currently experiencing rapid price growth and inflation has risen to levels last seen some forty years ago. The war in Ukraine is now the next major stumbling block for the global economy. Not only have oil and gas prices surged in recent weeks, but agricultural commodities such as wheat and corn have also become massively more expensive (graph 1).

The timing is extremely unfavorable, as central bankers are already struggling with the price pressures triggered by damaged supply chains.

Inflation before growth

Usually, central banks shift down a gear when there are geopolitical challenges, as we are currently experiencing with the conflict between Russia and Ukraine. However, the capital market cannot count on this support at the moment. In last week’s hearing before the US Senate, Federal Reserve Chairman Jerome Powell made two notable statements. When asked if the Fed would do anything it could to bring inflation under control, Powell answered with a clear yes. This means the Fed will accept a cooling of economic growth or even a recession to fight inflation. Moreover, the Fed Chairman admitted that supply-side problems were underestimated and that the withdrawal from ultra-expansionary monetary policy was therefore initiated too late. He thus indicated that the Fed has already made a policy mistake. For the time being, the Fed is therefore likely to focus only on containing inflation, and economic growth and geopolitical issues are not even secondary.

Implications of the Ukraine conflict

There are decades where nothing happens; and there are weeks where decades happen, Lenin allegedly said. The last few days have been a wake-up call for the West in particular, and the implications for the years ahead are likely to be enormous. Germany, for example, has announced that it will spend 2% of its federal budget on defense. The focus, however, is on globalization. The Covid-19 pandemic has exposed the limits of international integration, as the disruption of supply chains led to a supply shock and thus a rise in inflation. The war in Ukraine and the resulting renewed deadlock between the West and the East could further slow globalization. A long-term deflationary factor could thus disappear, favoring a rise in structural inflation. This development will have to be monitored very closely in the coming months.

Selection in a volatile environment

We expect a nervous market environment with high volatility in the coming weeks, which is likely to be driven primarily by developments around Ukraine. The Fed is anticipated to hike interest rates by 25 basis points for the first time next week. Liquidity has been our preferred asset class since the end of January and we continue to recommend a defensive positioning. In this environment, selection remains a key success factor. At sector level, we prefer materials and consumer staples to the overall market.