Prices are rising faster than expected

Concerns about the Covid pandemic have abated somewhat, thanks to successful vaccine rollouts and a gradual re-opening of many economies. However, the gradual return to normality has fuelled increased demand for goods and services around the world. This is happening at a time when global supply chains are still struggling with Covid-related bottlenecks and production constraints, especially in the energy sector.

This has led to far higher price inflation than anyone expected. For example in January, UK inflation reached 5.5%, its highest level for 30 years. And in the US, it hit 7.5%.

As consumers, we’re all aware of inflation. But we’re used to mostly small, gradual upticks in the cost of food, clothing and other items. So the recent surge in energy bills and petrol prices has come as a real shock to many of us, and has left some people wondering how they’ll make ends meet. The upshot is that consumers generally will have far less money to spend, and economic growth is likely to fall.

Central banks on guard against rising inflation

Central banks, such as the Bank of England and US Federal Reserve (Fed), are always alert to the risks of high inflation. Their usual method of combatting rising prices is to raise interest rates to discourage people from spending money. So, with prices soaring, central banks may be forced to increase interest rates more aggressively than initially predicted.

Indeed the Fed seems poised to raise rates at an accelerated pace. It also wants to pare back the stimulus package it introduced in the wake of the Covid pandemic. But the post-pandemic economic recovery is still fragile. And there’s concern that higher interest rates could make things even harder for companies already struggling with disrupted supply chains and rising costs.

With rates potentially rising faster, there’s particular concern about companies that have borrowed to fund expansion and growth. Technology companies in particular have borne the brunt of selling, with the technology-heavy Nasdaq Index in the US dropping about 10% from its record value at the end of 2021 by the end of February.

Crisis in Ukraine becomes a war

The world watched with mounting alarm as Russia continued to amass troops and weapons on its border with Ukraine. After repeated denials of an attack, on 24 February Russian president Vladimir Putin announced a “special military operation”. This, he claimed, was aimed at “demilitarisation” and “denazification” of Ukraine, and protection for pro-Russian Ukrainian separatists. However, the conflict has swiftly escalated into a major military attack, and we’re seeing grave and shocking consequences from a humanitarian point of view.

It has also fuelled concern among investors, with already jittery global stock markets falling significantly. At the same time, investments considered less risky, like UK and US government bonds, have performed well . Currencies like the Japanese yen and the US dollar have also found favour, as these too are seen as safe havens.

Where are markets headed in the short term?

No one knows how the conflict between Russia and Ukraine will pan out. Past events like this suggest that stock market volatility could subside quite quickly. But obviously this will depend on how the war evolves and whether other nations are drawn into the hostilities.

Where are markets headed in the medium term?

Looking ahead, provided the Russia-Ukraine crisis doesn’t spiral into a much broader conflict, and is reasonably short-lived (weeks/months and not months/years), then we’d expect the following:

• Oil and gas prices will remain higher for much longer, as concerted sanctions against Russia bite.
• Food prices will rise because Russia and Ukraine are big grain suppliers.
• Some parts of the auto industry will see further shortages on top of Covid-related supply-chain pressures.
• Because of all these factors, inflation pressures will last longer. That’s a big concern for central banks. They may be forced to raise interest rates at a faster pace at a time when the global economic recovery post-Covid is still fragile.
• It’s also possible the conflict could destabilise and hamper global economic growth – particularly in Europe. This scenario of low economic growth and high inflation would be a real challenge for central banks. Would they raise interest rates to dampen inflation, even though that would curb spending and growth? Clearly, the risk that central banks could make the wrong decisions has increased.

While the Russia-Ukraine crisis plays out, it looks like we’ll continue to see Russia ‘decouple’ from the world economy – in other words reduce its economic and trade links with other countries. However, this actually wouldn’t have a huge impact on the global economy as Russia is a relatively minor player in global trade and commerce. Far more significant would be an invasion of Taiwan by China, given China’s vital role in the global economy and the West’s reliance on China for goods and investment.

Hopefully that won’t happen. But the Russia-Ukraine crisis highlights the potential risks of global trade and over-reliance on other nations. It’s encouraging many countries to think about building up their own domestic supply chains so they’re less dependent on other nations. This will take time. But ultimately a more fragmented world would be likely to experience more geopolitical tensions and flare-ups, potentially making markets more turbulent.

Do I need to take action to safeguard my investments?

Global markets could remain turbulent in the coming weeks, given the degree of uncertainty over the likely outcome of the war. It can be painful watching the prices of your investments dip or sometimes fall significantly. So you may be tempted to take action to avoid further losses. But history shows that sitting tight and looking to the long term nearly always proves better for investment returns than making knee-jerk reactions.

History also shows that market volatility caused by events like the Russia-Ukraine war tends to be short-lived. And looking back to past major crises (such as the ‘dot-com’ bubble, the 2008 financial crisis and the market slump at the start of the 2020 pandemic), they show that share prices tend to recover given time.

We recognise though that you may be concerned about your investments. So if you have any questions, please don’t hesitate to contact your abrdn financial planner, who’ll be happy to help.

The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in. Information is based on abrdn’s understanding as at 10 March 2022.