Commodities go crazy, inflation and stimulus withdrawal keeps government bonds on the back foot and Irish commercial property punches out another solid 6% return for 2021. All these stories and more are covered in this week’s insights update from BlackBee.
The Russian invasion of Ukraine continued to dominate markets last week, particularly via incredible volatility in commodities. In the energy space oil prices initially spiked as the US and UK banned Russian oil imports and then slumped later in the week as investors speculated OPEC and others could move to boost their supplies. The world’s bread basket was also hit hard as wheat prices rose significantly given the Ukraine and Russia account for approximately 25-30% of global wheat exports. Nowhere were the panicky commodity moves more visible than in metals where nickel trading in London was suspended after prices rose six fold to $100,000 per tonne in a matter of hours! Our chart of the week this week illustrates the gains across each subsector of the commodity space so far this year.
In the midst of all these headlines it is difficult for investors to focus on the bigger economic picture. Our take is that the longer the commodity pressures (particularly the oil ones) persist, unfortunately the more acute the stagflationary pressure on the world economy in the short run. To use oil as an example, at current oil prices (if maintained) we estimate that the global oil spend could push towards 5% of GDP this year, a level where historically economic growth has started to come under pressure. At present oil futures curves suggest prices will ease but that they will still be over $90 per barrel in 12 months time so any short term respite from high energy prices looks limited.
The direct impacts of the conflict will be felt more intensely among those economies with the closest economic and geographic links. The Euro area is a good example of this, with the weaker euro last week a good ‘canary in the coalmine’ for how investors see the Euro area economy as vulnerable to a protracted conflict. However, in our view this also means different central bank reactions to the conflict. In the US we still believe the US Fed will begin to hike interest rates this week. However, despite elevated (and likely rising) inflation readings over the next few months we believe the first ECB rate hike could yet be pushed into 2023.
Last week was another difficult one for equity market investors as worsening news on the Russian invasion of Ukraine together with spiking oil prices led to heavy losses early in the week. Thankfully, some of the pressure eased as the week went on, particularly as oil prices went into reverse on hopes of greater global supply ex Russia. European equity markets and the euro proved quite vulnerable to negative news about the conflict over the course of the week but generally most equity market regions struggled. In addition, Chinese technology companies came under renewed pressure last week as a result of greater SEC scrutiny of their US listings. This was a factor in the weakness of the technology heavy Hang Seng Index over the course of the week.
Government bonds struggled last week even despite the continued conflict in Ukraine. The spectre of still rising inflation created more headwinds for government bonds as February US headline (7.9%) and core inflation (6.4%) both rose again compared to January. Last week’s ECB Monetary policy meeting also poured pressure onto government bonds in the Euro area. Even though it cut its economic growth forecasts for the Euro zone this year, higher inflation forecasts for this year together with an accelerated pace of withdrawal of bond purchases pushed bond yields in the region higher. In the credit space both high yield and emerging market bonds suffered losses with emerging markets struggling as Russian bonds faced default due to the pressure of economic sanctions.
As we noted above last week was an extraordinary week in terms of commodity market volatility with much of this centred around oil prices. The initial oil strength last week faded as reports emerged that the UAE was in favour of higher supply going forward and would encourage Saudi Arabia to pursue a similar approach to expanding supply further. Elsewhere in the energy space the EU announced ambitious plans to try to wean itself off the reliance on Russian gas, relying more on imported liquefied natural gas (LNG) and renewables as well as coal (in the short term) to reduce gas imports by two thirds over the next year.
Commercial Real-Estate – Solid CRE returns in Q4 and 2021, strong opening to 2022
Last week saw the publication of the Q4 2021 results for the JLL Irish Property Index which showed a solid performance for the asset class in 2021 and an improved return trajectory in Q4. Overall the Index returned 2.3% for the quarter and 6.1% for 2021 as a whole led by strong returns for industrial and residential assets. It was encouraging to see capital values for office assets improve in Q4 (up 1.3%) although the retail asset values still appear to be adjusting to the post pandemic environment with capital values still falling in Q4, this time by 2.9%.
Last week CBRE also published its bi-monthly review of the commercial real estate market. Office market demand improved in the second half of 2021 and in its view the unexpected easing of restrictions in January has only further fueled office demand in early 2022, particularly for those assets future proofed with strong ESG standings. Generally CBRE expects the positive office momentum to continue as workers return to offices and companies establish use patterns and predict space requirements, while those with expiring leases may opt to renew in the short term while a strategy can be established. The outlooks for the residential and industrial sectors are very much underpinned by lack of supply which has helped rents and values push higher over the past number of years. This lack of supply, particularly for the residential sector, speaks very much to the need for more international investment to improve the supply of housing for both rent and purchase. Finally, although the retail sector is still trying to stabilize, CBRE noted that the numbers of viewings is increasing which should point to more activity in the sector in 2022.