At the outset of 2022, all eyes were on inflation figures. The US annual headline inflation had reached 7.0 per cent and there was widespread speculation as to the actions of the US Federal Reserve. Tapering of the quantitative easing measures had begun, but the Fed funds rate still had a target range of 0-0.25%. It was to remain at that level until the middle of March.
In the meantime, on 24 February, Russia crossed a border – literally – that few thought any European country would cross in modern times: It invaded neighbouring Ukraine. Besides the horror and appalling moral aspect sending geopolitical shockwaves throughout the world, the invasion impacted financial markets in several ways.
It soon became apparent that Russia would cut its gas supplies to Europe, or imply threats to do so, as a means of forcing major European countries – Germany in particular – to curtail their support to Ukraine. Lower volumes and unscheduled maintenance cuts did not keep Germany from mothballing the planned Nordstream 2 pipeline, whereupon the existing Nordstream 1 pipeline was suddenly destroyed through a mysterious explosion in the Baltic Sea.
This pushed European prices on natural gas sky-high, reaching $400 per barrel of oil equivalent shortly after the invasion and then $530 per boe in August. As it became clear that Germany had acquired enough natural gas to last it through the winter, 2022 ended with natural gas for European delivery at approximately $140 per boe.
A closer look at gas prices reveals that the gas threat was probably prepared months in advance, as reduced volumes had made prices rise from the summer of 2021. Crude oil also became more expensive during this time, but after climbing to almost $130 per barrel in March, it slowly fell to $86 before the year was through.
Higher gas prices also led to higher electricity prices in Europe, fuelling inflation. In addition, as a consequence of the war, shipments of grain and other commodities from Ukraine were cut back or cut completely. In addition, bottlenecks arising from the pandemic had still not been resolved, adding to both a commodity boom and increasing inflationary pressures.
As the year came to an end, the Fed funds rate had been hiked by a total of 4.25 percentage points, with hints of more to come. The European Central Bank (ECB), which maintained a negative deposit rate all the way until the end of July, increased its key rates by 3.0 percentage points through the remaining five months.
“Some stock markets managed much better, however. In particular, the Norwegian OSE benchmark index fell by a mere one per cent. ”
The sharply higher interest rates had a devastating impact on global bond markets, dominated by long-duration bonds with fixed coupons. The S&P US Treasury Bond 10+ Year Index, meant to capture the performance of long-dated US government bonds (duration 16.3), fell by a staggering 29.4 per cent, after falling by 5.0 per cent the preceding year. In credit terms, these are as close to risk-free as can be had in capital markets. In terms of interest-rate risk, obviously, they are not.
Global stock markets were not jubilant either. The S&P 500 fell by more than 18 per cent (total return), with the MSCI World Index close behind at a loss of almost 16 per cent.
Some stock markets managed much better, however. In particular, the Norwegian OSE benchmark index fell by a mere one per cent. This relatively strong performance was partly due to the strong performance of local giant Equinor, on the back of higher gas prices as Norway and Equinor took center stage in supplying gas to Europe. In comparison, the local mutual fund index, mimicking UCITS regulations – meaning that Equinor is capped at below 10 per cent – fell by more than 7 per cent.
As a general conclusion, there is no doubt that 2022 was a challenging year for the markets in which Pareto Asset Management has invested clients’ capital.