There are a number of important events expected this week that will affect investors. The most important is undoubtedly the decision of the Federal Open Market Committee (FOMC) on US interest rates on Wednesday.
The Federal Reserve will have to decide how much to raise policy rates: by 25 or 50 basis points. A few weeks ago, before the outbreak of violence in Ukraine, 90 percent of market participants still believed that interest rates would be raised by 50bp at once. Now barely 10 per cent or less still believe that.
Frank Vranken, CIO of Edmond de Rothschild (Europe) in Luxembourg, sees a 25bp rate hike as the most likely scenario. “At the beginning of a rate hike cycle, a 50bp hike has never been made. Moreover, the conflict in Ukraine has economic implications that we cannot fully assess at this point. When we look at the futures markets, we see little direction. But a quarter point at each meeting between today and the end of June seems to me the most likely scenario.”
It also remains to be seen how the markets will react to the 117 million dollar coupon payment on an international Russian bond due on Wednesday. Will there be a default, or not? Russia had already threatened not to pay foreign investors or to pay them in roubles. The IMF, following Fitch, says that a default on Russian debt is imminent. Russia was not investable in the fixed income universe anyway, but a default could send additional shock waves through the markets.
Recession
The Fed finally seems to realise that rising commodity and energy prices could put lasting pressure on consumer confidence, which is beginning to wane.
According to the economic textbooks, there are three things happening simultaneously right now that can predict a recession: an inverted yield curve, a commodity shock and a Fed cycle that is tightening.
This, combined with the negative equity effect of falling share prices, could put serious pressure on consumers. Moreover, European consumers are hit much harder by high gas prices than American consumers as the US is a net exporter of energy.
Meanwhile, pessimism is running high in Europe. Jeroen Blokland of True Insights calculated that the risk premium on European shares is currently no less than 10 percent, which is historically high and truly exceptional.
The prediction that Europe would start to outperform this year will not come true, at least for the time being. Last week markets witnessed the biggest outflow ever from European equities, according to Bank of America figures. Europe will have to recover strongly with a sensible energy policy and European companies will have to increase their investments to keep up with their American counterparts. For now, America wears the cleanest dirty shirt of all markets.
This article appeared originally in Dutch on Investment Officer Belgium.
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