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Fed beats a hawkish drum

Last Week in the City provides a round-up of market movements and the global investing outlook. This covers week ending 8 April 2022.

| 9 min read

Investors are taking the prospect of high inflation and rapid rate hikes in their stride and appear relatively undeterred, despite the Federal Reserve becoming increasingly hawkish about future policy. The US central bank will start reducing its balance sheet next month and hinted that rate rises could be announced in quick succession. Concerns mounted about further hold-ups in supply chains – and their impact on inflation – as China locked down several cities including Shanghai as Covid-19 infections jumped.

A signal has been given in the bond market that could be a sign of recession. Here’s why we think that a recession is unlikely.

The blue-chip FTSE 100 index was up 0.5% over the week by mid-session on Friday, with the more UK-focused FTSE 250 down 0.6%.

Ukraine

Russia edged closer to a potential sovereign default as it set aside roubles to pay holders of international bonds that should be repaid in dollars and said it would continue to do so while its foreign exchange reserves are blocked by sanctions. On Monday, the US stopped the Russian government from paying holders of its sovereign debt more than $600m from reserves held at American banks, in a move meant to eat into its holdings of dollars. The Treasury Department had been allowing the Russian government to use those funds to make coupon payments on dollar-denominated sovereign debt on a case-by-case basis. Washington has now decided to cut off Moscow's access to the frozen funds completely.

However, Moscow is continuing to sell its oil and gas to help prop up its economy. Cargoes of Russian Sokol crude have sold out for next month, according to Bloomberg, with gas flows from Russia to Europe increasing since the invasion. It also noted that, Russian coal and oil paid for in yuan is about to start flowing into China. Nevertheless, Russia looks like it is heading for its deepest recession since the collapse of the Soviet Union, with UK government economists expecting Russia’s GDP will contract by between 8.5% and 15% this year.

Concerns about a recession prompted Russia’s central bank to cut interest rates from 20% to 17% on Friday.

The West continues to try and dampen the oil price. The 31-member nations of the International Energy Agency (IEA) – which include the US, most of Europe, Australia, Japan, Mexico and others – will announce the release of 120 million barrels of oil next week, the largest release in the IEA’s 47-year history. Around half of that amount will come from US reserves, which were included in Washington’s previously announced decision to release 180 million barrels of oil over six months. Oil prices fell by about 3% over the week. Concerns about a recession prompted Russia’s central bank to cut interest rates from 20% to 17% on Friday.

The US Congress removed the "most favored nation" trade status from Russia and its ally Belarus. This will allow the Biden administration to raise tariffs on imports from the two countries.

President Biden’s top economic adviser said the administration had warned India against aligning itself with Russia, saying a “more explicit strategic alignment” with Moscow would have “significant and long-term” consequences. India has so far declined to introduce sanctions and is continuing to import Russian oil.

Shell confirmed it will write off up to $5bn (£3.8bn) from offloading Russian assets as part of its plan to withdraw from the country. The company will no longer buy Russian oil, but contracts signed before the invasion of Ukraine will be honoured.

The UK government introduced further sanctions against Russia. The UK has imposed an asset freeze on Russia’s largest bank Sberbank, as well as the Credit Bank of Moscow – and an end to all new investment into Russia. Discover further detail on all UK sanctions against Russia.

Commodities

Global food prices hit a new record, rising at the fastest monthly rate in 14 years after the war in Ukraine hit supplies of grains and vegetable oils. March’s food price index from the UN Food and Agricultural Organization (UNFAO) rose to its third record high in a row, jumping by 34% from the same time last year. The index was 12.6% higher than in February, a rise that the UNFAO described as a “giant leap”. Vegetable oils, cereals and meat all hit record highs, while sugar and dairy products prices also rose significantly.

Purchases of gold exchange traded products (ETPs) hit a record in March. Global net inflows into gold ETPs rose fivefold month-on-month to $11.3bn in March, according to data from BlackRock, eclipsing the previous peak of $9.4bn in July 2020. The surge in buying helped push the gold price to within a whisker of its all-time high in early March, although it has since eased back.

Economics

We are now on the verge of the US Federal Reserve beginning its quantitative tightening (QT) programme. Fed officials "generally agreed" to trim $60bn per month from the US central bank's Treasury holdings and $35bn from its holdings of mortgage-backed securities, with the amounts phased in over a period of three months "or modestly longer," according to minutes of their March policy meeting. Balance sheet reduction, or quantitative tightening (QT) will involve the central bank selling the assets it purchased during the pandemic to support markets and keep interest rates low. During the pandemic alone the Fed bought $3.3 trillion of Treasuries and $1.3 trillion of mortgage-backed securities and it now holds around $9 trillion of assets.

Geopolitics

The upcoming French election could create a headache for the European Union and its markets – but the US mid-terms may be positive for those in the US.

Covid-19

Shanghai’s lockdown continues, with 24 million people subject to restrictions on movement in the City. Authorities have opened sprawling isolation centres for tens of thousands of people to isolate the growing number of positive cases. Lockdowns in other Chinese cities also continue putting severe pressure on transport and logistics across the country. As well as being a major focus of the financial industry, Shanghai is a hub for semiconductors, electronics and car manufacturing. It is also the world's busiest shipping port. The trucking industry is now subject to severe restrictions on drivers and deliveries to locations with positive cases, prompting concerns that shortages will once again be seen in supply chains, exacerbating China’s economic slowdown and inflation globally.

UK energy strategy

The UK government unveiled its long-awaited energy strategy, putting nuclear at the heart of its plans to reduce the UK's reliance on oil and gas. The key points are:

  • The construction of up to eight new nuclear reactors on existing sites, including two at Sizewell in Suffolk.
  • A doubling of targets for hydrogen production to help provide cleaner energy for industry.
  • Planning law reform to speed up approvals for new offshore wind farms, with a new target of producing up to 50 gigawatts of energy from this source by 2030.
  • For onshore wind farms the government wants to develop partnerships with "supportive communities" in exchange for cheaper energy bills.
  • The government will consider reforming rules for installing solar panels to help boost solar capacity by up to five times by 2035.
  • A new licensing round for North Sea projects is being launched in the summer.
  • There will be a £30m "heat pump investment accelerator competition" to make British heat pumps which reduce demand for gas.

Solar and wind power have well-known intermittency issues – they do not generate power when the sun doesn’t shine, or the wind doesn’t blow. How can technology bridge this gap?

Environmental, social and governance (ESG)

US President Joe Biden plans to invoke the 1950 Defense Production Act (DPA) to boost the domestic supply of minerals used in the manufacturing of electric vehicles (EV) and large capacity batteries. The Korean-War-era powers will be used to ramp up lithium, nickel, cobalt, graphite and manganese supplies – with an announcement expected soon, reports suggested. The White House wants to reduce the country’s dependence on overseas energy and other commodities in moves that predate the current crisis in Ukraine. The DPA allows Washington to compel companies to prioritise government contracts over private deals. In terms of actual financial incentives, mining companies will be able to access $750 million from a federal fund.

Technology

A regulatory filing in the US disclosed that Tesla boss Elon Musk had acquired a 9.2% stake in Twitter, sending shares in the social-media group up by 20%. The stake cost Mr Musk $2.9bn and he is now Twitter’s biggest shareholder – and he was also appointed to the company’s board after the purchase.

HP shares gained trading after Warren Buffett’s Berkshire Hathaway bought a stake in the laptop maker valued at more than $4.2bn. Berkshire has now become the company's largest shareholder, with a 12% stake.

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Fed beats a hawkish drum

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