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Inflation headwinds continue to stifle global markets

Inflation headwinds continue to stifle global markets

09 Jun 2022

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Month in brief

  • Equity markets continue to struggle to shake off inflationary pressures despite rallying at the end of May
  • Oil prices hit a 2 month high in the final days of the month after the EU agreed a plan to stop the majority of its Russian oil imports
  • The UK Consumer Prices Index reached 9% in the 12 months to April
  • Long dated UK gilt and index-gilt yields finished the month more than 1% higher than where they started 2022

Global and emerging market equities finished the month marginally down. Index linked gilt yields rose rapidly at the end of the month.

The S&P 500 briefly dropped into bear market territory (a 20% fall from its most recent peak) but rose back out almost immediately to spark a market rally in the final week of May. UK equities had a more positive month, returning 0.7%. The outlook for equities remains uncertain, with heightened levels of volatility, as inflationary headwinds and global growth concerns are expected to persist for some time.

Both investment grade and high yield corporate bonds continued to struggle during May, driven by a combination of rising gilt yields and widening credit spreads on the back of worsening global economic forecasts. The World Bank is now predicting a worldwide economic contraction with a series of coronavirus lockdowns in China fuelling its concerns.

After much debate, and resistance from some members, EU leaders settled on a plan to try and immediately reduce the reliance on Russian oil and gas across the continent. The price of Brent crude oil rose to its highest level for over 2 months in the aftermath of the announcement, compounding inflationary pressures across the UK, US and Europe.

UK CPI hit yet another all-time high in April with the Governor of the Bank of England admitting that the combination of double-digit inflation and a potential recession later this year is an increasing possibility. Expectations for long term future inflation have fallen back in recent weeks though and are now broadly at the same level they started the year.

Eurozone inflation hit a record high of 8.1% in May and US inflation came in slightly under expectations at 8.3%. This was down on the previous month but higher than anticipated.

Gilt yields in the UK have experienced their sharpest rise since 1994 from their recent trough in December 2021. Fixed interest and index-linked gilts again posted negative returns over the month. Index-linked gilts were especially hampered by their longer maturity and a moderate reduction in future inflation expectations.

Some pension schemes will have seen significant improvements in their funding position in recent months with rising gilt yields driving down long term liabilities, this is despite the falls experienced in equity markets.

In May alone, the aggregate funding position of UK DB Pension Schemes improved by over 3% and its possible that your scheme is better funded than you thought. Check out our May Investment Briefing for more information on what rising gilt yields could mean for your de-risking journey. Click here to read the paper.

The charts above are based on data from The Pensions Regulator, the PPF 7800 Index and the XPS data pool. The assumptions used in the UK:DB long-term target basis include a discount interest rate of gilt yields plus 0.5%. The assumed asset allocation is 16.9% equities, 20.0% corporate bonds, 6.9% multi-asset, 5.1% property, 3.8% private markets and 47.3% in liability driven investment (LDI) with the LDI overlay providing a 60% hedge on inflation and interest rates.

For further information, please get in touch with Tom Potter