Global equities (-4.6%) declined in the first quarter. Volatility spiked sharply amid rising geopolitical instability, tighter monetary policy to address accelerating inflation, and fears about the global economic growth outlook, partially offset by generally improving COVID-19 trends and a resilient economic backdrop. Russia’s large-scale military attack on Ukraine, which Russian President Vladimir Putin labeled a “special military operation,” forced over four million people to flee Ukraine as fighting intensified and living conditions deteriorated rapidly in many cities. US and NATO allies imposed severe economic sanctions on Russia, largely cutting off the Russian economy from global financial markets and limiting the ability of the Russian central bank to take counteractive measures. Prices for natural gas, select grains, and metals surged, and Brent crude oil prices topped US$100 per barrel amid expectations that sanctions would cripple Russian energy exports and restrict supplies of key commodities. Despite uncertainty about the economic risks posed by the conflict, most global central banks showed greater urgency in scaling back monetary stimulus and pressing ahead with interest-rate hikes due to heightened concerns about soaring inflation. The Bank of England (BOE) was the first major central bank to raise its policy rate, hiking rates twice during the quarter, while the US Federal Reserve (Fed) lifted rates for the first time since 2018. The number of COVID cases generally declined across most countries, with Hong Kong and China notable exceptions. In China, the authorities reported nearly 100,000 infections nationwide and imposed strict testing and lockdowns in several areas, including a two-phase lockdown of Shanghai and its 26 million residents. 

Global fixed income sectors suffered one of their worst-ever drawdowns during the first quarter, as government bond yields rose sharply following more aggressive monetary policy tightening intentions in response to persistent inflation pressures. Most fixed income spread sectors underperformed government bonds amid an expected slowdown in economic activity and tighter financial conditions, exacerbated by uncertainty arising from the Russia/ Ukraine conflict. Nevertheless, spreads recouped a portion of their widening late in the quarter. 

Commodities (+33.1%) surged as all four sectors generated outsized returns against a volatile macroeconomic backdrop following Russia’s invasion of Ukraine.

Equities

US
US equities (-4.6%) registered their first quarterly loss since March 2020. Fears about the economic implications of Russia’s large-scale military attack on Ukraine and the prospect of aggressive monetary policy tightening by the Fed drove the S&P 500 Index into correction territory in February. However, stocks rebounded sharply in March amid strong equity inflows, the belief that the US can resist current economic headwinds better than other nations, and Fed Chair Jerome Powell’s assessment that the US economy is strong enough to withstand higher interest rates without slipping into recession. Robust consumer demand combined with stretched supply chains and soaring commodity prices caused consumer and producer prices to rise faster than anticipated. Inflation soared to a four-decade high, as the headline Consumer Price Index rose 7.9% annually in February (6.4% at the core level). In March, the Fed raised interest rates by 25 basis points (bps), lifted its 2022 core inflation forecast to 4.1%, and cut its 2022 GDP growth forecast to 2.8%. Increasingly hawkish Fed rhetoric prompted financial markets to recalibrate for faster and potentially larger rate hikes, in addition to a swifter reduction of the Fed’s US$9 trillion balance sheet. US corporate earnings in the fourth quarter of 2021 were stronger than expected, with companies in the S&P 500 Index registering year-over-year earnings growth of approximately 30%. President Joe Biden signed into law a massive US$1.5 trillion spending bill, which included substantial increases in domestic and national security programs and US$13.6 billion of aid to Ukraine. 

Economic data released during the quarter signaled a revival in the US economy following a dramatic decline in the number of COVID cases. The exceptionally tight labor market continued to drive wages higher, adding significant upward pressure to inflation. Nonfarm payrolls surged above expectations during the quarter, while the unemployment rate dipped to 3.8% in February, and initial jobless claims ended March at the lowest level since 1969. In February, discretionary spending and retail sales slipped after strong gains in January, as consumers tempered purchases against a backdrop of rapidly rising prices. High inflation, which markedly outpaced wage growth and dented future income prospects, was a drag on consumer confidence. Despite robust demand, the housing market faced headwinds from lean housing inventory, rising mortgage rates, and sharply higher prices for homes and building materials. The manufacturing sector grew at a more modest rate compared to the prior quarter, although the sector remained firmly in expansionary territory. Manufacturers benefited from improvements in the labor supply but remained hampered by rising input prices and renewed materials shortages. The Institute of Supply Management (ISM) Services Index dipped to a one-year low of 56.5 in February. However, preliminary data for March signaled the largest gain in service-sector output in eight months amid a sizable increase in new business, thanks to more relaxed COVID restrictions. Small business sentiment waned over the quarter, with inflation, supply problems, and a lack of qualified employees negatively impacting sales and earnings for many businesses. 

Within the S&P 500 Index (-4.6%), nine of the 11 sectors posted negative results for the quarter. Communication services (-11.9%) was the worst-performing sector, weighed down by the entertainment (-18.9%) and interactive media & services (-13.5%) groups. Consumer discretionary (-9.0%) underperformed, led lower by specialty retail (-21.1%) and hotels, restaurants, & leisure (-8.3%). Information technology (-8.4%) fell, with the software (-10.9%), semiconductors & semiconductor equipment (-10.4%), and IT services (-9.2%) groups detracting the most. Energy (+39.0%) was the top-performing sector as the price of oil soared. Utilities (+4.7%) rose due to strength in the multi-utilities (+11.4%) group. 

Europe
European equities (-5.2%) finished lower after a volatile quarter. The Russia/ Ukraine conflict clouded the outlook for economic growth in Europe amid considerable uncertainty about the war’s impact on inflation, supply chains, and consumer demand. Soaring energy and food prices drove eurozone inflation to a record high of 7.5% in March. Markets grew increasingly wary about the potential for a further acceleration in prices over the coming months, which would place additional pressure on household real incomes and spending. Europe sources approximately 40% of its gas from Russia, and supplies are increasingly vulnerable after Germany halted the certification process of the Nord Stream 2 pipeline. The European Union and the US created a joint task force to help reduce Europe’s reliance on Russian energy, but shifting suppliers is likely to be difficult as many of the potential suppliers are already locked into long-term contracts. The European Central Bank (ECB) shifted to a more hawkish stance in March, as policymakers were more determined to confront inflation despite fears that the war in Ukraine could drag Europe into recession. The ECB now expects to end net purchases under its asset purchase program in the third quarter and to taper the remaining asset purchases at a faster pace. The bank also downgraded its 2022 economic growth forecast to 3.7%, from 4.2%, and significantly raised its inflation forecast for 2022 to 5.1%, from 3.2%. 

The expansion in Europe’s manufacturing sector slowed during the quarter, as the eurozone Manufacturing Purchasing Managers Index (PMI) slipped to a 14-month low of 56.5 in March, down from 58.7. Soaring energy costs and the impacts of the war in Ukraine offset stronger demand from relaxed pandemic restrictions. Services sector demand improved once economies opened more broadly after the Omicron wave subsided, although services activity was constrained by higher costs and renewed supply-chain disruptions. Eurozone economic sentiment in March fell to its lowest level since the beginning of the pandemic, driven primarily by plunging consumer confidence. Business confidence sank to a one-year low on a sharp drop in production expectations. The eurozone unemployment rate ebbed to 6.8% in February, as the labor market recovered from pandemic-induced losses. 

In the UK (+4.8%), the Bank of England (BOE) raised interest rates to 0.75% in March but softened its stance on additional rate hikes amid concerns about the real-income shocks from rising living costs. Chancellor Rishi Sunak’s budget was widely criticized for its failure to address the cost-of-living crisis amid rising tax burdens and surging energy prices, which drove consumer price inflation to a 30-year high of 6.2% in February. In Germany (-10.9%), investor confidence in March dropped at a record pace to the lowest level since the onset of the pandemic amid fears that soaring inflation may derail the economic recovery. Chancellor Olaf Scholz announced a monumental shift in Germany’s defense and security policy, opening the door to a stronger European engagement in the transatlantic defense architecture. In France (-6.6%), President Emmanuel Macron’s lead over far-right candidate Marine Le Pen narrowed ahead of presidential elections in April.

Emerging markets
Emerging markets (EM) equities (-6.1%) sold off during the quarter. Russia’s invasion of Ukraine riled equity markets, and China’s largest COVID-19 outbreak since the onset of the pandemic prompted new lockdowns that threatened to significantly disrupt supply chains. Within EM, Latin America was the top performer, followed by Asia and Europe, the Middle East, and Africa (EMEA). 

Latin America (+13.8%) generated outsized gains. Easing political tensions in the region supported stocks, while the crisis in Ukraine drove energy, grains, and metals prices sharply higher, which benefited the region’s economies that rely heavily on commodity exports. Peru (+34.9%) and Chile (+20.0%) skyrocketed amid surging metals prices, particularly for copper, and Colombia (+23.5%) was propelled higher by a rally in oil. Brazil (+16.0%) was advantaged by soaring energy and agriculture prices and large capital inflows from foreign investors seeking to take advantage of higher interest rates and attractive valuations. Mexico (+5.9%), a major manufacturer of energy-intensive machinery, transport, and electrical equipment, was negatively impacted by high inflation but still generated attractive returns. 

Asian equities (-7.3%) were dragged lower by China (-13.9%). Russia’s war with Ukraine put China in a precarious position, as authorities sought to preserve ties with Russia and mitigate any further fallout with Western nations. The central bank continued to shift toward a more accommodative policy stance to combat slowing economic growth, property market strains, subdued consumer sentiment, and lackluster domestic consumption. Renewed lockdowns across many cities, including Shenzhen and Shanghai, sparked fears about factory closures and manufacturing disruptions, placing new pressures on China’s economy and threatening to further impair supply chains. The government pledged to enact measures to support the economy and financial markets, while President Xi Jinping signaled a shift in priorities, announcing that Chinese leaders must seek to mitigate the economic and social impact of virus-control efforts. Renewed fears of supply-chain disruptions and ballooning energy prices weighed on South Korea (-7.7%) and Taiwan (-3.2%), given their dependence on exports and energy-intensive manufacturing. India (+0.1%) finished flat, while Thailand (+3.8%) and the Philippines (+3.9%) showed signs of economic improvement amid easing COVID-19 restrictions. 

EMEA (-5.8%) was the weakest performer, led by Russia (-100%), which suffered its largest capital market drawdown following severe foreign sanctions, the closure of the Moscow Exchange, and the removal of Russian securities from major equity indices, including the MSCI Emerging Markets Index. Although trading partly resumed on March 24, Russia introduced a strict permitting process for foreign investors which requires onerous documentation, and sanctions remain in place. The vulnerabilities of Central and Eastern European economies to sustained military conflict weighed profoundly on Hungary (-17.9%) and Poland (-6.7%). The Czech Republic (+3.1%) remained vulnerable to these risks, but its direct access to European Union (EU) recovery funds could enable a faster economic recovery. Turkey (+25.0%) surged amid the ongoing depreciation of the lira against the US dollar, while South Africa (+10.3%) rose sharply as the strength of commodity prices aided the economy.

Fixed Income

Most global central banks shifted toward more hawkish monetary policies in response to stronger inflation pressures, while others pledged to be mindful of the economic impact of the war in Ukraine and adjust policy as necessary. The Fed hiked interest rates for the first time since 2018, projecting seven total rate increases during the year (December’s forecast signaled three), increasing its inflation forecast and reducing its economic growth estimate.

Acknowledging the economic growth headwinds and uncertainty related to the Russia/Ukraine conflict, the ECB expects to conclude asset purchases in the third quarter, after which it may consider rate hikes. The Bank of Canada hiked rates for the first time since the onset of the pandemic, while Norway’s Norges Bank lifted its policy rate again and indicated the likelihood of additional hikes due to higher price and wage pressures. The Swiss National Bank and the Bank of Japan (BOJ) maintained negative policy rates. 

Global GDP growth diverged but continued to expand across most countries during the fourth quarter. Surging commodities prices following Russia’s invasion of Ukraine, along with labor shortages and supply-chain disruptions, added to the inflation impulse. In the US, the labor market grew for the 14th consecutive month, the unemployment rate declined, and wages rose steadily. Chinese manufacturing and services PMIs contracted, hurt by a resurgence of COVID-19 cases and geopolitical uncertainty. The increase in energy costs pushed Japan’s current account deficit to its highest level since 2014. Eurozone consumer confidence was dented by concerns about the war in Ukraine and soaring energy prices. The UK’s manufacturing PMI and industrial production rose more than expected, bolstered by domestic demand and improving global supply-chain issues. 

Global sovereign yields moved sharply higher led by short-end yields. Even as global economic growth expectations were downgraded, major central banks pursued more hawkish policy stances amid views that the recent acceleration in inflation is likely to persist due to energy supply shocks. The market continued to rapidly reprice Fed hike expectations, and the Federal Open Market Committee signaled a willingness to increase the pace of rate hikes if it continues to fall further behind the inflation curve. UK central bank Governor Andrew Bailey tempered the outlook for future rate hikes amid the BOE’s expectation that falling real disposable incomes in the UK due to tax and energy price increases will create an offsetting demand shock. The BOJ enforced its yield curve control limits by buying Japanese government bonds (JGBs) as the yield on 10-year JGBs approached the upper band of 25 bps. EM central banks took more aggressive policy measures to counter the inflation shock. Major Latin American central banks remained hawkish, although the Central Bank of Brazil signaled that a likely policy rate hike of 100 bps at its May meeting could be the last rate increase in this cycle. Asian central banks were relatively inactive. China stepped up policy easing through fiscal and monetary support to counter domestic and external economic headwinds and achieve its 2022 GDP growth target of approximately 5.5%.

Currencies

The US dollar ended mixed as hawkish rhetoric and monetary policy actions by major developed and emerging market central banks limited the scope for broad dollar appreciation via pro-US dollar rates divergence. Additionally, strong commodity prices benefited commodity-linked currencies, driven by helpful terms-of-trade shifts. Across developed and emerging markets, currencies of commodity exporters (Australian dollar, Canadian dollar, New Zealand dollar, Brazilian real, South African rand, Colombian peso) strongly outperformed the currencies of commodity importers (Japanese yen, the euro, British pound, Indian rupee, Turkish lira). The Japanese yen fell to a seven-year low as rising US yields led to a widening of the interest rate differential between the US and Japan. The BOJ’s move to defend its yield target likely added to the weakness in the yen. The Swedish krona underperformed, driven by its geographical proximity to the Russia/Ukraine conflict. In EM, Latin American currencies were notable outperformers. The Russian ruble failed to benefit from commodity strength, as the US and Europe sanctioned the Russian central bank, oil export volumes dropped, and the country was forced to sell oil at a significant discount to global benchmarks. Additionally, Russia prohibited citizens from transferring hard currency abroad.