Equity markets sold off heavily in June after US inflation came in above expectations, which prompted the Federal Reserve to hike its overnight rate by 75 basis points, the largest rate hike since 1994. More interest rate increases are expected.

This aggressive monetary policy triggers concerns of a potential recession in the United States. During the first quarter of 2022 US GDP decreased by 1,6%. Second quarter GDP will be announced in late July and the US economy would officially be in recession if there are two consecutive quarters of negative GDP growth. Also the FED now acknowledged that a recession is possible, but predicts a soft landing, meaning they expect it to be short and not escalate into a full-blown crisis.

In our opinion the FED has a tendency to downplay the risks in an attempt to calm the markets down, only to confirm the actual situation later on when it has already occured. Likely the US already is in a recession and whether it will have a soft or hard landing in our view mostly depends on the labor market. If US companies resort to mass layoffs then the likeness of a hard landing increases. So far however, the US labour market is holding up very well with an unemployment rate of just 3,6%, near the lowest recorded over the past 50 years, so that is a good sign.

Furthermore, core inflation, which excludes food and energy, has declined for the second consecutive month – from 6,5% in March to 6,2% in April and 6,0% in May. So, although the numbers came in above expectations, they are nonetheless in decline. Overall inflation on the other hand (including food and energy) is still on the rise, hitting a fresh 40-year high of 8,6% in May. This suggests that food and energy are the main drivers of the rising inflation. Energy prices however are now on a rapid decline. The price of natural gas dropped 33,41% in June, crude oil dropped 7,77% and gasoline prices in the US are reportedly declining daily for several weeks already.

Our expectation from the beginning of this year was that inflation will start coming down by itself as a result of easing consumer demand somewhere around the second quarter of this year. The unexpected invasion of Ukraine added more inflation pressure, thus postponing it, but we may now finally be at that reversal point. If it does, investors' expectations on additional interest rate increases will temper, which in turn we expect to cause optimism and move the market back into positive territory during the second half of this year, despite the imminent threat of a recession.

June however was still red across the board with the S&P500, Dow Jones and Nasdaq indexes dropping 8,39%, 6,71% and 8,71% respectively. Also Europe booked heavy losses with the DAX, Eurostoxx and CAC40 losing 11,15%, 8,82% and 8,44% respectively. The Slovene SBITOP index dropped a more modest 2,14%. The only equity market with significant positive returns was China where a potential end of lockdowns and supportive monetary policy helped sentiment. The Hong Kong Hang Seng index gained 2,08%.

While the European Central Bank is expected to raise their interest rate fort he first time in July, the more aggressive approach by the FED caused the dollar to gain 2,34% against the Euro to 1,0482 USD/EUR. Another reason for the dollar gain is because investors consider it a safe haven currency. The strength of the dollar in June pushed gold down 2,22% to 1807,30 USD per ounce.

Rudy Marchant
Fund manager Primorski skladi d.o.o. Koper

Monthly reports - June 2022