Pitfalls & Pitch Calls: Welcoming the winds of change in all their uncertainty

This article first appeared in Wealth, The Edge Malaysia Weekly, on February 28, 2022 - March 06, 2022.
Pitfalls & Pitch Calls: Welcoming the winds of change in all their uncertainty
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The surge in Omicron infections in Malaysia continues. Yet, thankfully, the mortality rate remains flat and our healthcare system has somehow managed to stay ahead of things. Vaccination has been a strong defence against getting seriously ill and having to be hospitalised. Kudos to our healthcare professionals and fellow Malaysians for taking active steps to get vaccinated. 

As the economy starts to recover from the 2021 lockdowns and supply chain disruptions, the fear of inflation returns to haunt markets after US consumer price inflation data printed a 7.5% increase in January. This has fuelled expectations that the US Federal Reserve may start raising interest rates more aggressively than anticipated.

This development has increased volatility in global markets since the turn of the year. The acceleration of inflation on the heels of strong wage gains has even prompted some traders to speculate the possibility of a 0.5% hike by the Fed in March or increasing the key policy rate seven times in 2022, by 0.25% each time. 

The base assumption is for the Fed funds rate to rise from the current 0.00%-0.25% level by 0.25% in March, May, June, September and December, making it a total of five rate hikes in 2022. The reason for this forecast is that inflation is expected to peak in April or May, as this year’s price increases ease from last year’s rapid gains. This is sometimes called the base effect. The bond market and many economists also expect consumer price inflation to subside over the course of the year to below 5% by December 2022 and then ease to 2% by end-2023. 

It would be unwise to rule out the Fed tightening even faster, depending on how inflation and employment data pan out in the coming months. However, a 0.5% hike in March may be unlikely unless Fed chairman Jerome Powell explicitly signals such a move beforehand. It was only last month that the Fed chairman predicted that inflation would cool later this year, so a 50-basis-point rate hike would indicate some degree of panic from the US central bank and may even cause it to lose some credibility.

Having said that, markets will stay volatile in the short term as investors grapple with global uncertainties, especially inflation and how aggressively the Fed will tighten policy in the coming months. On top of that, markets are grappling with the uncertainties from the current Russia-Ukraine crisis that has added geopolitics into the equation. 

The immediate impact, in the event of a Russian invasion, is on commodities such as wheat, corn and energy. A price surge could fuel more inflation fears. Ukraine, Russia, Kazakhstan and Romania all ship grains from ports in the Black Sea, which could face military action or sanctions. Ukraine is the world’s third largest exporter of corn and the fourth largest exporter of wheat, according to International Grains Council data. Russia is the world’s top wheat exporter.

Energy markets may also be hit if there is conflict, as Europe relies heavily on Russian gas transiting through Ukraine. According to Eurostat, Russia provides Europe with more than 40% of its natural gas supply. Oil prices are up sharply by more than 20% so far this year and the energy sector is the best performing equity sector, having risen 23% so far this year (based on the MSCI World Energy Sector Index). Given the near-term oil market tightness and geo-political events in Ukraine, a further near-term price overshoot for oil above US$100 a barrel if tensions worsen cannot be ruled out.

Metals could also be impacted as Russia is a major supplier of aluminium, and semiconductor companies too could be affected, given the reliance of many semiconductor manufacturers on Russian and Ukrainian-sourced materials like neon and palladium, according to a report by market research group Techcet. According to Techcet’s estimates, more than 90% of US semiconductor-grade neon supplies come from Ukraine, while 35% of US palladium is sourced from Russia.

While the short-term impact is wide and varied, the only person who can forecast an invasion of Ukraine remains the one and only Vladimir Putin. 

Therefore, the outlook remains one that is moderately positive on global equities. And historically, geopolitical events tend not to cause long-term impacts on market trends, and investors do better by staying invested over the course of the specific events. For example, in 2014, when Russia invaded Crimea, a region in Ukraine, markets took a dive in the immediate aftermath but rebounded within a month. 

Lastly, on interest rate hikes, the bull markets do not end at the beginning of rate hike cycles, and positive trends in global economic growth and earnings continue to be positive fundamental drivers for the market. Equity valuations are still reasonable while real interest rates remain negative. There is also a large amount of dry powder, with a near-record US$4.6 trillion cash sitting idle in US money market funds — this should offer market support.

Long-term investors should stay diversified and have a balance of assets in their portfolios, including some exposure to bonds, which tend to be generally less volatile than equities. Investors would do well to remember that while expectations are for risk assets to perform in 2022, the winds of change mean uncertainties are aplenty and markets will trade in a more volatile manner as monetary and fiscal policy become less accommodative compared with the previous two years, and economic and earnings growth rates ease from their peaks in 2021.


Michael Lai is executive director of wealth advisory (wealth management) at OCBC Bank (M) Bhd