War in Ukraine and Fed rate tightening
The first few months of 2022 have been rough for investors. Global markets are down nearly 10% in Q1 and the S&P 500 Index entered correction territory in February. Two major events have put additional pressure on markets: War in Ukraine and the U.S. Central Bank Policy. The S&P 500 ended the quarter at -4.9% and the MSCI Europe and MSCI EAFE also struggled, with returns of -5.9% and -6.6% respectively. The S&P/TSX fared better, ending with a gain of 3.1%.
On February 24, Russian President Vladimir Putin ordered a military attack on Ukraine. Global stocks fell while bonds increased. Oil, measured by West Texas Intermediate (WTI), initially broke through US$100 a barrel, a level not seen since June 2014, but has since retreated to US$96 a barrel.
Fed interest rate announcement
On March 16, the U.S. Federal Reserve announced a 0.25% increase in interest rates—the first increase since 2018, signaling what looks like the start of a rate-tightening cycle. You could compare these tightening cycles to a mountain the Fed must climb, increasing rates to reach its final goal of full employment, stable prices, and moderate long-term interest rates. If they can get there, and how soon remains to be seen.
What this means for investors
There’s no previous rate-tightening cycle that mimics the current environment, with geopolitical risk, supply chain issues, or pandemic-impacting inflation or economic growth levels factoring into the Fed’s decision-making process. However, we can use some general rules of thumb:
- geopolitical conflicts typically are top of mind to investors for a short period of time
- the U.S. Federal Reserve is usually cautious during the early stages of a tightening cycle and when markets correct (a selloff of 10% from the peak)
- the dismal performance to start the year is unlikely to continue moving forward.
As the year progresses, we continue to believe that the Fed will raise interest rates less than the six times that’s currently being priced in and that Russia-Ukraine tensions will ease, leading to a pivot in the negative narrative that has unfolded since the start of the year. Over the next few months, the geopolitical premium built into oil prices today will likely go away, but supply-and-demand dynamics will continue to support oil prices above US$90 a barrel as global economies continue to fully reopen leading into the summer.
A change toward less hawkish sentiment coupled with a good fundamental backdrop provides a positive path forward for returns. The key to success in investing is to stay focused on what matters and understand the environment so that you can adjust to the changes if necessary.