Your weekly economic update from the team at FXD Capital

Conflict in Ukraine is the main driver behind market volatility right now. Each day brings whipsaws off the back of diplomatic tensions and the drip-feed of news releases. This week alone, there have been rumours of troop pullbacks, followed by skirmishes and shell fire days later.

War tensions continue to ratchet up, with rising expectations that Russia may play its card once the Winter Olympics end. While markets have been preparing for conflict, which has contributed significantly to 2022 losses, the situation now results in an inverted VIX (volatility curve). The backwardation effect, where volatility prices fall over time, indicates that prices will flatten out by early summer, meaning expectations for either a short conflict or another three months of escalated tensions. Safe-haven government bonds have performed well over the past week, paring back the losses inflicted from pressures of rate rises.

A conflict would exacerbate some of the simmering inflation trends which currently dominate headlines. Ukraine is a major producer of wheat, and a disruption to its harvest would ripple through food markets for the foreseeable future. The situation is very nuanced because Russia in itself would suffer greatly. Its domestic stock market and Rouble currency have been in freefall, and continual financial sanctions would impede the local economy.

UK inflation figures released on Wednesday showed a 5.5% annual increase for January, steady with the previous print of 5.4% in December. While these days it’s a forgone conclusion that inflation exceeds the BoE target (2%), levels are now at their highest since 1992’s high of 7.1%. While core inflation (which excludes energy, food, alcohol and tobacco) is running at a lower rate of 4.4%, the anticipation will be to see whether the rises taper off after April when the energy price cap kicks in.

Looking at ONS data, the highest components of UK inflation are house-related and transport/communication costs. Drivers behind the former are the continual supply chain issues, with everything from semiconductor shortages and shipping container prices increasing by ever-higher multiples. Higher energy prices will be passed on to consumers regarding transport costs. The supply/demand dynamic shift of lockdowns ending and demand returning for travel offer beleaguered suppliers the opportunity to pass on the pains of the past two years.

Recent Federal Reserve meeting minutes highlighted the central bank’s resolve to combat inflation without damaging the broader economy and stock market. The layman’s translation equates to: they want to raise rates, but they don’t want to burn down the house in the process. The minutes were also pertinent for disclosing that there was not a large consensus of voters behind inflicting a significant rise of 0.5%

In March, the next meeting has a market consensus for a rate hike; the question is not if, but the magnitude of the bump up.

The inflation narrative is also starting to affect one of the most stubborn resistors of all – Japan. For three decades, inflation has averaged at 0.3% annually, but 2022 may ring in changes, with forecasts of a rise to a heady 1.1%. For some time now, Japan was seen as a comfort blanket for western nations perplexed by the effect of QE on stifling inflation and wage increases. In the end, it took a global pandemic to break the cycle, and Japan, with a more internally-concentrated economy, is not immune to the same problems now blighting the west. Real wages have barely grown over the past 20 years, and with an ageing economy, falling birth rate and negligible immigration, it’s now facing widespread labour shortages across services sectors.

All the best for the week ahead 




Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.

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