Insurance Insights Q1 2022: Macro outlook and implications for asset markets

In the first quarter of the year, persistently high consumer price inflation in many Western countries coupled with soaring geopolitical risk premia have created uncertainties over major central banks’ monetary policies and increased the potential for central bank policy error.
Over the coming quarter, financial markets will continue to focus on the tragedy in Ukraine. Already, the Fed’s geopolitical risk index has risen to levels not seen since 9/11 or the Iraq war. Concerns over economic and financial sanctions against Russia have led to a selloff in Russian assets, rising commodity prices, and higher volatility.
Thus far, markets have moved towards a risk off stance, but not indiscriminately so. Safe haven assets such as gold, USD and US Treasuries have rallied in response. It’s becoming clear that a drawn-out military confrontation with longer-term economic consequences are a possibility. A soft economic landing is looking less likely.
While trade links between the US, Europe and Russia are relatively weak, the commodities market may be key to the outlook of the global economy. Europe in particular is more vulnerable, given that Russia supplied 29% of Europe’s crude oil imports in 2020 and 39% of its imports of petroleum products.1 A possible move towards energy rationing could curtail the European economic recovery.
Further, commodity prices are an important factor behind a rise in inflation. Oil prices have reached a 14-year high and natural gas prices have more than doubled.2 In addition, Ukraine is the breadbasket of Europe as a major grain exporter and Russia produces a significant supply of global metals and minerals. Should we see a supply shock, the fallout from a commodity price spiral may prove to be severe.
Stagflation risks have also risen, and the Fed will have to be careful in order to navigate the combination of upside inflation risk and downside growth risk. US headline inflation for January hit 7.5% y/y and wages grew by 5.7% y/y.3 The decline in spending power and consumer confidence could lead the Fed to enact a slower monetary tightening timeline. Growth could take a hit if geopolitical risk tightens financial conditions materially and fosters uncertainty for businesses.
In Asia, impacts are likely to be uneven. Energy exporters such as Australia and Malaysia stand to benefit while energy importers such as India and the Philippines could be on the wrong end of the stick – as elevated oil prices could encroach on their current account deficits and fuel inflationary pressures. China could be more insulated as the People’s Bank of China embarks on a monetary loosening schedule.
Going forward, volatility is likely to persist for some time as markets digest developments around the war in Ukraine. In our view, investors may seek to remain well-diversified across assets to weather this storm. Given the macro picture, it may be prudent to be overweight commodities and countries which are exporters in energy, agriculture, and metals. Investors may also consider an allocation to alternatives as a diversifier.
Footnotes
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1
BP Statistical Review of World Energy and Invesco. Data as of July 2021.
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2
Bloomberg. Oil prices reference WTI futures and natural gas prices reference ICE NBP Natural Gas futures. Data as of 7 March 2022.
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3
US Bureau of Labor Statistics (BLS). Data as of Jan 2022.