The inflation scare that’s dominated much of the investment backdrop this year keeps finding new ways to send shockwaves through markets.
On Monday, investors awoke to the idea of China locking down Beijing -- a city of more than 20 million people -- adding to worries about supply stresses that are keeping the heat on prices. U.S. stocks fell as much as 2.9%, the most since early March, following a decline in European equities. A rush for havens saw U.S. Treasuries, European bonds and the dollar rally.
“Inflation is definitely front and center of investors’ concern, and of course the China story feeds further into that inflation pressure because China is the mother of all supply chains,” said Janet Mui, head of market analysis at Brewin Dolphin. “That concern is intensifying across the board, whether you are talking about the goods side or the services side.”
The inflation flare-up, along with the increasingly aggressive response of central banks, is already taking a toll on demand, spending and corporate earnings. Russia’s invasion of Ukraine has compounded concerns about both price pressures and economic growth, with some seeing a danger of a bout of stagflation.
It’s a toxic combination for markets, with stocks, bonds and currencies all taking their cue from a price spike that many once hoped would be transitory, but is proving to be much more damaging to households and companies.
In the U.S., the S&P 500 Index has slumped for three weeks in a row, and is at its lowest level since mid-March. It appears ready to join the ongoing bear market, Morgan Stanley’s Michael J. Wilson warned in a note Monday.
Amid the inflation danger, most monetary authorities are now racing to respond, pulling their emergency Covid stimulus and increasing interest rates to fight the fire. China’s central bank is in a different position, and on Monday it cut the amount of money that banks need to have in reserve for their foreign-currency holdings.
Bond markets are well advanced in pricing the massive policy shift underway, acknowledging that more than a decade of ultra-easy money is on the way out. The market value of bonds with sub-zero yields has collapsed to about $2.6 trillion, according to Bloomberg data. As recently as the end of 2020, the stockpile stood at over $18 trillion.
The latest inflation concerns come hot on the heels of tough talk late last week from Federal Reserve Chair Jerome Powell, who endorsed the idea of “front-loading” policy tightening. The European Central Bank could start raising interest rates as soon as the summer.
That’s left investors assessing the risk of a European or U.S. recession. Such concerns were highlighted last week by the International Monetary Fund, which slashed its world growth forecast by the most since the early months of the Covid-19 pandemic, and projected even faster inflation.
Neil Shearing at Capital Economics says the market narrative for the post-Covid period has flipped from “Roaring Twenties” to “Recessionary Twenties,” though he cautions that reality is likely to be more complicated than that blunt idea.