While equity and bond markets have for some time discounted the start of a monetary tightening cycle, both took fright when the minutes of the US Federal Reserve December meeting were revealed in early January 2022. The overall tone appeared to have turned more hawkish than recent meetings, most significantly it was no longer just about tapering and interest rate rises, the focus had also turned to reducing the overall size of the Reserve’s balance sheet, currently standing at close to $9 trillion. The market’s fear was that what had begun as an inflation scare had the potential to turn into an outright growth problem as the once abundant central bank liquidity was drained from the market. Despite some soothing words from Jerome Powell that any action would not impact growth, equities slumped, and bond yields rose across the globe.
The selling in equities was, however, far from indiscriminate. Stocks classified as growth, including those from the technology and discretionary sectors, bore the brunt of the sell-off while value shares including financials and energy fared far better. While the Federal Reserve does appear ahead of the ECB in terms of tightening, an early estimate of the Eurozone’s harmonised index of consumer prices for December 2021 highlighting a year-on-year increase of +5% suggested their roadmaps will be broadly similar with only the timing out of kilter. Russia’s confrontation with Ukraine further exacerbated what were already jittery markets particularly toward month end when the US ordered the families of their diplomats in Kyiv to leave the country.
All this came at a time when, or perhaps because, covid related restrictions continued to be eased in many countries. While some still required to tighten existing measures, it was becoming increasingly clear that the omicron variant, while still virulent, was highly unlikely to be severe enough to warrant the economic carnage inflicted by its predecessors. This glimmer of hope was far from enough to save the MSCI Europe ex UK Index which fell by -5.2% over the course of the month.
Our focus now turns to the European earnings season which should provide an illuminating insight into expectations for 2022. While we have every reason to expect an overall positive message the commentary is likely to be tinged with a sense of apprehension as the spectre of inflation and central bank policy error looms over the economic landscape.