Notable News: ECB policymaker says rates will rise ‘very soon’

A group of European Central Bank (ECB) policymakers have voiced their intent to end the central bank’s stimulus programme and to raise interest rates.

Backdrop: The ECB is taking longer than other central banks to change its “easy money” policy. It continues to put new money into the financial system. The recent rise of inflation in the Euro zone is forcing the change to a more hawkish position. The upcoming rate hike would be the first one in a decade.

The ECB president Christine Lagarde said she expected the bank to stop expanding its balance sheet through asset purchases around July and to then raise rates “some time” after that.

Some numbers:

• Inflation hit a historical record of 7.5% in April.
• The ECB’s deposit rate is currently -0.5%, charging banks for keeping their cash at the central bank. They’ve been in negative territory since 2014.

Consequences? It’s hard to know for sure, but the tightening of credit conditions and the removal of new liquidity might cool down the economic activity of an already weakened European economy.

The Fed faces similar problems with its more aggressive stance regarding inflation. However, the challenge faced by the ECB is probably greater due to the Russia-Ukraine war and the disruptions it has caused (more on this later).

What could go wrong? The ECB can try to lower the demand for goods and services, but they can’t do much about the supply, at least not directly. Supply chain issues may not resolve or may even get worse. Even if demand goes down due to the ECB’s hawkishness, there might still be a mismatch between demand and supply that results in continued inflationary pressures. In fact, the tightening of credit and liquidity conditions could slow down, stall or lower economic output, causing even more of a mismatch.

Macro: Outlooks for EU growth and inflation worsen as energy crisis hits

Forecasts of economic growth in the EU are being tampered by the expectations of continued disruptions caused by the Russia-Ukraine war and the associated inflationary pressures. Some of the main concerns are the price and availability of energy and commodities. The impending tightening of the ECB’s monetary policy is also a headwind for the European economy.

Some numbers:

• Both the EU and euro are forecast to grow 2.7% in 2022, below the previous 4% expectation.
• Year-over-year, energy prices in the euro were up 38% YoY in April. Food prices were up more than 6%.

Other considerations: Even though they are all suffering from high inflation, different countries within the EU have different problems. For example:

• Not all EU countries are affected in the same way by the sanctions imposed on Russia.
• Some countries rely more than others on Russian energy exports.
• The countries with higher levels of debt-to-GDP could find themselves in a more delicate situation.

Even if we consider all those countries as one single economic block, the EU isn’t the only economy that is facing high inflation and the risk of recession. Other economic areas are also grappling with supply chain issues and the rise of interest rates, damaging global growth expectations.

Stocks: Global Stock Slump May Not Be Over

Most major stock indices of the world have been losing value since late 2021 or the beginning of 2022. Other asset classes have also been hit hard. It is estimated that around $11 trillion dollars of value have been wiped out of markets.

• S&P500: Down -16.91% year-to-date.
• NASDAQ: Down around -25% YTD.
• STOXX Europe 600: Down -12.46% YTD.
• Nikkei 225: Down -13.38% since September 2021.
• Shanghai Composite Index: Down -15.55% YTD.
• iShares MSCI ACWI ETF: This ETF tracks the performance of an index composed of large and mid-cap companies in developed and emerging markets.
  It is down -16.33% YTD.

These numbers are just from indices, not all stocks or sectors have performed the same. However, it seems clear that there is bearish sentiment across the board. Which begs the question:

Is the sell-off over or is this a trend that might continue?

Prices are cheaper now than they were a few months ago. If the downtrend were to be over, it could be an opportunity to buy quality stocks at a relatively reasonable price. But It’s hard to tell whether now is the moment to try to deploy capital.

Prices could keep on going south, for various reasons:

• Inflation doesn’t affect all companies the same, but in general, high levels of inflation can raise operational costs and eat into the profit margins of companies.
• The rate hikes in response to high inflation are meant to decrease consumer demand, potentially damaging the future earning potential of some companies.
• The cost of financing operations with debt goes up, putting financial pressure on overly indebted entities or reducing the creation of new credit.
• The future cash flows of companies are discounted with a higher interest rate, lowering the theoretical value of the shares in the present.

It’s probably safe to assume that the markets have been getting used to the idea that there are major headwinds for most companies and their share prices in the immediate future.
In any case, slowly scaling into interesting stock picks can mitigate the risk of not really knowing if the bottom is in.

Other Markets: Wheat prices rise almost 6% as India export ban shakes markets

India prohibits some of its wheat exports. It’s not a complete ban, but the amount of exports will be severely limited. The price of wheat futures has increased by 6.48% percent today and has gone up around 12% since May 12, just a few days ago.

• India’s wheat production is set to fall a bit after rising for six years.
• India is trying to mitigate high inflation, especially in the prices of food.
• There are also rising concerns about food security.

The problem: Food prices over the globe were already trending up even before the beginning of 2022. We’ve seen rising costs and the disruption of supply chains for important agricultural inputs, like fertilizers.The problem was made worse with the impact to global trade of Russia’s invasion of Ukraine. India’s policy of reducing exports isn’t helping.

Some stats:

• Ukraine accounts for 11.5% of global wheat exports.
• Russia accounts for 16.8% of global wheat exports.
• India is, after China, the second largest producer of wheat in the world, and produces almost the same amount as Russia and Ukraine combined.
• Despite the massive amount of wheat produced in India, it is ranked 8th among wheat exporters.

It has been made clear that relying heavily on imports of foodstuffs poses risks. Governments are taking food security more seriously. Unfortunately, food protectionism is causing food prices to go higher, as global buyers have to satisfy their needs with a smaller supply of food.

India’s move could have the unintended consequence of disproportionately affecting poor nations that import wheat. The World Food Program, a United Nations agency, has warned that an additional 47 million people could go hungry as the war’s ripple effects add to an existing crisis of steep increases in food prices and a fertilizer shortage.

Some countries are already seeing protests because of this.