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Sadly, one of the background stories to this quarterly review continues to be the tragedy of the ongoing war in Ukraine, and its economic and market impact. The war has been going on for over seven months now, with no apparent end in sight as Russia recently announced mobilisation of troops and made further threats against the West. It’s no surprise that its impact continues to ricochet through markets – especially commodity markets and the broader energy industry.

On top of that, the global economy was further affected when new UK Prime Minister Liz Truss’ administration made a much larger-than-expected budget deficit inducing mini-budget announcement. This was intended to usher in a period of stronger and more dynamic growth for the UK economy. Instead, the announcement caught investors by surprise and led to falls in the price of government bonds, causing a significant increase in market interest rates. We also saw the pound drop to an all-time low against the dollar before later recovering some ground.

Craig Hoyda, Senior Quantitative Analyst, takes a closer look at how Russia’s invasion of Ukraine is affecting global growth, how markets have responded to the mini-budget, and how governments and central banks around the world continue to battle increasing inflationary pressures.

Gloomy tidings for the global economy

The global economy is facing many issues, which seem increasingly likely to end in recession. China’s economy is still suffering as a result of its ‘zero-Covid’ strategy, although growth is expected to rebound as the worst of the lockdowns ease. Russia is in a sharp recession because of Western sanctions, even if it’s not as serious as first expected. And in Europe, the energy-price spike is driving deterioration in trade, squeezing household incomes and stifling consumption. UK markets are also experiencing a period of extended volatility due to concerns over inflation and the public debt implications as a result of the now ex-Chancellor’s September mini-budget announcement. However, markets welcomed the appointment of new Chancellor Jeremy Hunt and his reversal of some of the previously announced government changes. Overall, this budget will cost the government £32bn a year less than the mini-budget and appears to have had a somewhat stabilising effect on markets, for the time being at least.

With so much going on right on our doorstep, it can be difficult to focus on the wider picture and the biggest challenge to the global economy. This currently lies in the US where we’re seeing excessive levels of inflation. Unfortunately, there’s likely to be a significant rise in unemployment before this is brought under control. In turn, this is likely to lead to further sharp interest-rate hikes and ultimately a recession.

A contraction in the world’s largest economy would have a significant negative effect on global growth, especially when combined with the difficult financial conditions being faced in many other developed and emerging economies.

Market uncertainty, some respite, more uncertainty

It’s interesting that, as the economic clouds continued to gather, bond and equity markets did manage to regain some of their poise after the weakness at the start of this year. Some of this may reflect the old ‘better to travel than to arrive’ saying, with those earlier declines anticipating the gloomy headlines that are now front-page news. Bond markets had also taken comfort from the occasional inflation number that wasn’t quite as bad as originally feared.

However, this recovery was short-lived. Markets were again thrown into disarray following the UK government’s fiscal policy announcements, which included an energy price cap and a ‘mini-budget’ focused on large debt-financed tax cuts. Globally, expectations on the likely path of both inflation and interest rates have also ebbed and flowed leading to further volatility in markets.

With inflation and interest rates already at such high levels, the UK announcement added to investors’ concerns around the trajectory of inflation and public debt. This sparked a sharp and, at times, disorderly sell-off in UK assets.

The size of the debt, together with the market reaction, has put the onus on the Bank of England to react, with markets now pricing in much higher interest rate hikes by the end of the year, than previously expected. As a result, our previous forecasts for the path of rate increases now look too low, which in turn implies that the looming recession we’ve been forecasting is likely to be deeper than originally expected. Events, however, are rapidly unfolding as evidenced by the government reversing course on at least one of their proposed tax cuts

A complex investment path lies ahead

Although we saw some improvement in markets at the start of the year, the outlook remains a complex one. While ‘unprecedented’ has become an overused word, it does unfortunately describe much of the current global political and economic landscape.

However, and as ever, there will always be investment opportunities for those willing to do their homework and hold their nerve. At times like these, it’s important to remain calm and remember that you’re investing for the long term. And if history tells us anything, it’s that markets can recover from periods of instability like we’re currently seeing.

If you’re not sure how market and economic events may affect your investments, or are concerned about the impact, consider speaking to a financial adviser. If you’re already an abrdn client, get in touch with your financial planner. If you don’t have an adviser, find out about how our financial advice services can help you.

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 in October 2022.