The central banks’ dilemma

Fears of a recession are increasing as a result of rising inflation and interest rates. Inflation has remained high, driven by an extremely strong labour market, high commodity prices and delays in global supply chains following the pandemic. The war in Ukraine and China’s handling of Covid-19 have further worsened the supply problems.

For the month as a whole, the US S&P 500 Index fell by 8.3 per cent measured in USD, while the European Stoxx 600 Index dropped by 8.0 per cent measured in EUR and the Nordic VINX Index decreased by 4.2 per cent measured in NOK. Here in Norway, the Oslo Stock Exchange Benchmark Index (OSEBX) declined by all of 9.1 per cent.

Tight monetary policy with no slowing down

The global economy is still solid and labour markets are generally record-strong. This is a good scenario for the central banks to increase interest rates in and thus control inflation, which is tending to run wild in several places. The fact that interest rates are rising from the extremely low levels we have had for a long time – during a period with an extremely aggressive monetary policy to support the economy through a global pandemic – is actually a healthy sign. However, the challenge facing the central banks is how to tighten up the monetary policy, and thus raise interest rates, without contributing to a full halt in the economy and a drop in global demand. If people’s buying power and consumption slow too much and the labour markets also weaken, a global downturn, or recession, is right around the corner. Interest rates are now rising, but we have not yet seen other signs of a recession. This is what the financial markets are currently focusing on, and the way in which the central banks deal with this challenge will set the direction for the markets over the next 6-18 months.

The reporting season

In 2022, the financial markets have to a large extent been affected by macro conditions, such as interest rates and inflation, the war in Ukraine, commodity prices and the energy crisis. However, we are now approaching the end of the half-year and a new round of company reports, and with them an update on how higher interest rates and inflation are affecting listed companies’ activity, earnings and outlook. So far, companies have managed to navigate a number of challenges well, and earnings expectations for 2022 are still much higher than those for 2021. However, the market has priced in both strong measures by the central banks and slightly weaker company outlooks, and this pricing thus allows for an upside if the market’s many concerns lessen following the reporting season and during the autumn.

The road ahead ...

Measured by the MSCI World Index, global shares fell by around 7.8% measured in local currency in June and have fallen by 18.3% so far this year. Although consumer confidence has fallen significantly, the strong labour market should counteract an immediate risk of recession. If we now see inflation level off and fall in the second half-year, there is reason to believe in a growth pause instead of a global recession. If we avoid a recession, the stock market once again appears attractive and offers a number of exciting investment opportunities.