• European political and energy disturbances
  • Finally, ECB made the move

The July was very favorable for developed equity markets. The US S&P 500 index (S&P 500 Total Return EUR Index), which represents major 500 US companies increased by 12.28% during the month. Similar result was delivered by broad developed markets (MSCI World Total Return EUR Index), which generated double digit positive return and increased by 10.67%. Except for Emerging markets where the result was not as good as in developed markets, but also, generated positive 2.28% return. One of the factors which contributed to outperformance of developed markets were better than expected earnings.

The weaker consumer spending and declines in investment both business and residential influenced the contraction in the US economy. US GDP fell an annualized 0.9% in the second quarter after the contraction of 1.6% in the first three months of the year. While the largest economy in the world shrank for a second straight quarter – meeting one of the rules of thumb for defining a recession, economists and Federal Reserve Chair Jerome Powell are still skeptical that US economy will plunge to deeper recession because of the strong labor market. Based on the available data and broad activity it is not yet consistent with a contraction of the economy that is typically thought of as recession. The economists agree that more likely we could face the recession not earlier than at the beginning of 2023. however, the GDP data shows that the economy is slowing down now. The household finances are in good shape right now, so even if the economy goes into recession, they are entering the recession with less leverage and in far better financial condition than they did in previous crises.

Despite that economy may be nearing the recessionary period, Fed policy makers raised their benchmark interest rate by another 75 basis points as they try to bring inflation down to the desired levels in the medium term. The essential fuel for the economy is one of the strongest ever labor markets which allows to have tight monetary policy and fight against elevated inflation.

While US is focused on controlling the inflation, it seems that Europe faces more challenges than elevated inflation and increased energy prices. Current political turbulence in Italy was triggered by one of the governing coalition party boycotts, with prime minister Mario Draghi offering his resignation, which was rejected by the president at the time. Italian President Sergio Mattarella rejected Mario Draghi’s offer to resign as prime minister in a bid to avert a political crisis that would unsettle financial markets and potentially lead to elections in the fall. After unsuccessful attempts to unite the governing coalition, the prime minister Mario Draghi stepped down.

UK prime minister Boris Johnson announced at the beginning of July that he is stepping down form his position. He was forced to do by rebellion of his own cabinet and parliamentary group after three years of continuing scandals. 

Unrest did not bypass Germany either. The Russian gas giant Gazprom closed its main pipeline to Europe which ends in Germany. Gazprom declared force majeure event on several European natural-gas buyers signaling that it intends to keep supplies capped. The company has been delivering less gas than ordered by customers over the past month, citing problems with turbines at its main pipeline. Despite that, gas shipments were restored but only at 40% of capacity which was further reduced to only 20% in the end of July. The control of gas supply became the tool of political blackmail.

Regardless the fact that European politics faces unexpected issues and increased uncertainty during this time, the European Central Bank raised key interest rate by 50 basis points, the first increase in 11 years and the biggest since 2000 as it confronts surging inflation. Also, policy makers unveiled a new monetary policy tool which they expect will ensure that markets do not push up borrowing costs too much in vulnerable economies, as happened in 2012.

10 year Government Bond Yield

Source: Bloomberg L.P.

Irrespective of all political shocks, bond markets showed resilience. Chart 1 above shows that bond yields decreased (bond price increased) in major regions welcoming central banks’ actions to fight against elevated inflation.

“House view” update

Luminor Investment management team decided to maintain lowered risk allocation budget and higher exposure to defensive sectors (utilities, healthcare, and energy). High uncertainty about possible consequences of the war in Ukraine, tightening monetary policy, high volatility in the markets and slowed economic growth warrant such decision.

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