World financial markets endured a volatile first quarter as stock and bond prices suffered corrections and ended the period lower by mid-single digit percentages. In a year when market expectations were high and buoyed by the prospects of a receding pandemic, investors instead were shocked by a protracted land war in Eastern Europe that has been increasingly difficult to predict. The Ukrainian-Russia conflict brings with it a myriad of negative macro-economic consequences including high energy price inflation and volatile commodity prices. Unfortunately, there is no end in sight to this humanitarian crisis.
Despite the geopolitical turmoil, asset prices have been resilient. Thus far, the U.S. economy has been able to maintain its growth trajectory, propelled by a recovering job market that saw 1.7 million new jobs created in the first quarter, resulting in a strong 3.7% unemployment rate. In addition, leisure travel has recovered to about 90% of pre-pandemic levels as the U.S. consumer emerges from the health crisis in decent financial shape.
Around the world, rampant inflation is becoming a major economic risk as gas prices reach record highs and food costs increase monthly. In response, the Federal Reserve, in coordination with other central banks, has begun the process of tightening monetary policy by hiking interest rates. With the initial interest rate increase completed in March, the Fed’s goal is to lift the benchmark Federal Funds rate to 2.5% by yearend, with the hope that price stability will be reestablished in the broader economy.
Looking ahead, Chairman Powell and the Fed have the difficult task of taming inflation without pushing the broader economy into recession. Certain market indicators are already flashing warning signs, including the bond market where the reality of higher interest rates is translating into elevated borrowing costs for businesses and, potentially, weaker company profits. There is also a corollary to the health of the real estate sector, where higher mortgage rates are beginning to have a negative impact on house prices. Consequently, we expect more asset price volatility for the remainder of the year as the global economy adjusts to entrenched supply-demand imbalances, while markets struggle with limited visibility around key geopolitical and macroeconomic developments.