21 March 2022 - China's Covid, a war and Central Banks raising rates: still a rally




Global equities continued their ascent and are now mostly trading above the levels of the day the war started. It is remarkable that this rally took place during a week when China imposed fresh lockdowns in cities with Covid19 outbreaks, the war is raging, and two major central banks raised interest rates. But it also shows the hope that markets usually discount, in their attempt to come out of the fear environment. And that fear has been evident since January 1st first with respect to the fact that the FED will not be the markets friend anymore and has culminated with the threat of a third world war since February 24th.


The biggest turnaround was evident in Chinese equities, which slumped during the first two days of the week, only to rally back hard towards the end of it. The catalyst were the announcements of senior economic advisors to President Xi that strong stimulus is coming in the first quarter (which is ending next week, so rather soon) and that the property sector will have to be protected. Even more importantly there were news that the Chinese authorities are working closing with the US authorities on the compliance issues that Chinese companies are facing in the US, with respect to their accounting standards and transparency. All in all, it could be that we have seen the worst for equities in that region.


The FED raised interest rates by 0.25%, as was anticipated. Even more importantly it pre-announced that it will continue raising rates throughout the year, confirming market expectations for rates to be closer to 1.5-2.0% towards the end of the year. It is now a reality that the FED will engineer a slowdown in the US economy in its efforts to fight inflation. As Mr. Powell put it in the press conference “the jobs market is too strong maybe, and not healthy”, reminding all that the way that inflation was finally brought down in the early 80s was when the decision was made to let unemployment rise and the economy to fall into a recession. We are far from a recession for the moment, but a slowdown should be our base case.


The US February Producers Price Index (PPI) was announced lower than expected. The monthly increase was 0.8% against expectations for 0.9%, but most importantly the Core PPI, which excludes food and energy rose by just 0.2%, which is the lowest monthly increase since December 2020. Of course, these numbers were taken before the start of the military conflict, which has changed dramatically the situation in commodities and other raw materials.


The Bank of England raised interest rates to 0.75%, for the third time in a row, but provided a rather soft guidance for the remainder of the year. Essentially one can conclude that they are going rates perhaps one more time, to 1.0% and they are done for 2022.


Hopes remain high for a peace agreement between Ukraine and Russia, although the Russian side has been increasing its military action in the region, bombarding cities relentlessly. The fact that NATO has explicitly rejected the idea of military involvement in Ukraine has made markets calmer that a third world war can be avoided, while the weakness of Russia to bend Ukraine’s resistance after three weeks raises hopes that Putin will eventually compromise and reach a deal.


Government bond yields rose in anticipation of the FED’s announcements but have remained stable since. The move higher was more pronounced at the short end of the yield curve, with the 2-year US bond yielding now close to 2% and they start to look attractive again for investors. The 10-year yield rose to 2.20% before the announcement and has settled to around 2.15% afterwards, as the market is starting to price an economic slowdown.


Oil prices collapsed to 95$, after rallying to 130$ just a week ago. However, as the weekend approached WTI Crude Oil returned to 105$ because a rapid escalation in the Ukraine situation could always happen.


Charts of the Week


Investment Grade bonds are those which are considered of higher quality, although their ratings vary from the absolute perfect AAA to the lowest rating of this category which is BBB-. The spread is the difference these bonds are yielding over the “risk free” yield of the US or the German government bonds for example. The higher the spread, the higher the return for the investor when he buys them. This charts shows that the spread of these, rather safe, bonds is up, at around 150 basis points (bps) which is the highest since 2018, when again the FED became more aggressive with interest rates hikes. If one takes into account that the government bond yields have also moved higher, especially in the 3–5 year maturities, then the actual returns of this category for the investor are perhaps at their best levels in the last 5 years. Of course, during the pandemic crisis of March 2020 the spreads shot up to almost 350 bps) but one should not just wait for such very rare incidents to invest.



The chart above shows the price of the MSCI World Index, which after a rally of two weeks it is trading at a level higher than the first day of the war. Global equities have shown, once again, that military conflicts although tragic for human lives, they are not the cause of major bear markets. On the contrary, as we had argued before, they mark most of the times the bottom of a market as investors are focusing on what happens next. And what happens next for the moment is a big unknown, but there have been positive signs from the on-going negotiations between the two sides. while the biggest positive remains the insistence of NATO to stay out of the conflict. All signs point to assuming that we have seen the bottom for now: a) support by the governments with oil subsidies, b) oil pries 20% down from their peak, c) cash levels in funds at record highs d) very negative sentiment which is a contrarian indicator e) trillions of cash waiting to be deployed f) April-May traditionally good months, Of course, the situation remains very fluid.




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