What is the outlook for the global financial market in H2?

US. economic growth could continue to stall and asset prices are likely to fall further. 

How has 2022 been so far? Well, it’s not been good if you’re a consumer as surging inflation has eaten into your income. It has not been good for businesses that have had to absorb some of the surge in costs in their profit margins, nor for those looking to hire workers given the extremely tight labour markets. It has not been good if you’re an investor in financial assets either, as bonds and stocks have gone down.

Will the second half of the year be any better? Barring any positive shocks, it seems unlikely to us that the second half of the year will be much better. Inflation should prove stubborn, economic growth should continue to stall and asset prices are likely to fall further. At best, declines in asset prices might not be as bad as the first half of the year. At worst, we could be on the precipice of a dramatic lurch lower for risk assets such as equities and corporate bonds.

The growth outlook is undoubtedly very poor as central banks try to wring demand out of the economy in order to contain price pressures. If inflation were just a question of demand strength, there might be some hope that central banks could get inflation back under control. But supply is still the main problem, not demand, and however much central banks supress demand, it might not be sufficient if supply lurches lower.

The biggest threat here seems to be from the disappearing Russian gas supply. Europe fears that Russia could turn off the taps. Should that happen, it would be another huge stagflationary shock that would spread from Europe to the rest of the world. But even if gas supplies are maintained, we find it hard to believe that most of Europe can avoid a recession, while the prospects of similar downturns in seemingly stronger nations, such as the US, seem high as well. As the risks of recession grow, some demand-sensitive prices will probably fall back. This could include energy and will undoubtedly create optimism that inflation could start a significant and long-lasting decline.

But even if we do start to see some weakness in energy and other commodity prices, the problem is that all sorts of other more insidious price pressures have developed that not only take the place of some of the more volatile components, but threaten to persist for some time. Annual inflation rates still seem likely to come down (the UK will be an exception), but progress will likely be disappointing in Mr. Steve Barrow, Head of Standard Bank G10 Strategy’s view.

This, in turn, will mean that central banks have to take policy rates up by more than generally expected and will be slower to bring them back down. Such actions will frustrate investors who want to buy bonds and stocks on the back of falling policy rates. Worse still, the persistence of policy tightening, allied to weaker growth, should exacerbate bond market strains in those countries where debt loads are high, or where there’s hefty borrowing in the dollar.

How will currencies fare through all this? Mr. Steve Barrow argues that the trends so far in 2022 have been driven by two factors: the speed of policy tightening and movements in the terms of trade. In short, countries with positive terms of trade effects from the surge in commodity prices, and fast policy tightening, enjoyed currency strength, with the US dollar and Canadian dollar leading the way.

On the flip-side, adverse terms of trade effects and slow policy changes from the likes of Japan, the UK, and the euro zone have hurt their currencies. "In the second half of the year, we might expect some catch-up on rates from the laggards, while terms of trade effects are unlikely to be as significant, particularly if recession concerns weigh on commodity prices. But we still doubt that this will mean a reversal of the trends we saw in the first half of the year. Instead, given the increasing risks of financial markets fracturing, we’d place an emphasis on safe asset currencies, such as the dollar and Swiss franc, while the yen, which languished in H1, could be the one currency to reverse its fortunes in H2", said Mr. Steve Barrow.