Commentary on financial market developments – June 2022
- Fears of a financial recession
- Continued rise in inflation
- Rising key central bank interest rates
Global financial markets continued to be largely negative in June. Smaller increases were forecast for the world economy, and by almost a third than originally expected. While the world economy grew by 5.7% in 2021, it is expected to grow by only 2.9% this year. At the same time, the risk of global stagflation is growing and, according to the latest data from the US Federal Reserve, the US economy already appears to be in recession at the moment. The markets have reacted to these unfavourable macroeconomic developments with a strong sell-off in stocks, bonds and commodities. On the other hand, the US dollar performed strongly in an environment of strongly elevated global risk aversion.
The US S&P 500 index (-8.4%) is already down 20% year-to-date, entering a bear market. A bear market is defined as a decline of more than 20% from the previous peak. US macroeconomic data disappointed strongly in June. The US inflation rate rose further to 8.6% when 8.3% was expected. This is the highest inflation in 40 years. Also on a month-on-month basis, the US inflation rate surprised significantly to the upside. The main engine of the US economy, the US consumer, is thus clearly stalling, which does not bode well for the dynamics of the US economy in the months ahead. On Wednesday, 15 June, the US Federal Reserve held a meeting. The Fed raised the target range for the key interest rate by three-quarters of a percentage point (0.75%) to 1.50%-1.75%. Economists had expected an increase of only half a percentage point (0.50%). Moreover, Fed chief Jerome Powell indicated that he expected a further increase of half to three-quarters of a percentage point at the next meeting at the end of July. The Fed also significantly downgraded the outlook for the US economy in its new economic forecast. At the same time, the Fed expects the US unemployment rate to rise in the coming months. As for the outlook for interest rates, the Fed governors’ indication is that they should rise by another 1.75% by the end of this year to a target range of 3.25%-3.50%. The US economy is probably already in recession at this point. Meanwhile, an economic recession is defined as two consecutive quarters of GDP decline. In the first quarter, US GDP fell by 1.6%. And on Thursday 30 June, the Atlanta branch of the US Fed released an updated estimate of US GDP growth for the second quarter, which is -1.0%.
During June, the European Central Bank held its first meeting in a long time as it signaled to investors that our long period of cheap money is coming to an end. In fact, the ECB has decided to end its quantitative easing (QE) program on July 1. At the same time, we will have to prevent the gap between bond yields from widening too much until maturity in the troubled southern wing of the eurozone and Germany, so we may yet see continued quantitative easing in some form. As a point of interest, the yield to maturity of the Italian 10-year government bond has now risen above 4%, which, with the Italian government debt to GDP ratio above 150%, has meant that many investors have once again begun to question the financial stability of the entire Eurozone. At the same time, the ECB promised to raise its main deposit rate by a quarter of a percentage point each time at its next two meetings (in July and September). Recall that the ECB’s main level rate is currently -0.5%, so this announcement marks the end of negative interest rates. At the same time, the ECB presented a new forecast. For Eurozone GDP growth, which is expected to be 2.8% this year and slow to 2.1% next year. Even so, many economists believe that this forecast is too optimistic given recent developments. The estimated average inflation rate in the EU is expected to be 6.8% this year and 3.5% next year,
Consumer prices in the Czech Republic continue to rise very strongly. Year-on-year inflation has accelerated and has risen again from 16.0% in May to 17.2% in June. This is the highest level since December 1993. According to some economists, annual inflation could peak in the middle of the year at up to 20% and consumer prices are currently expected to rise by around 15% for the whole of this year. The first signs of slowing demand give hope of a slowdown in inflation in the second half of the year. On Wednesday 22 June, the Czech National Bank held a meeting. The CNB surprised some investors when it raised the base interest rate by 125 basis points (1.25%) from 5.75% to just over 7%. This will make mortgage loans more expensive again, but on the other hand, banks and financial institutions are already offering us quite interesting appreciation on deposit products or financial instruments that appreciate the value of customers’ invested funds through bank repo operations. The CNB meeting was also the last meeting of the old composition of the Bank Board. From 1 July, the current Governor Aleš Michl will take over the Governor’s seat, while three new members will join the Bank Board: Eva Zamrazilová, Jan Frait and Karina Kubelková. The new composition of the CNB Bank Board is expected to keep interest rates stable. On the other hand, if the inflation rate in the Czech economy continues to rise strongly, the Bank Board would very likely have no choice but to tighten monetary conditions further, primarily through higher interest rates.