Active Thinking

At GAM Investments’ latest Active Thinking forum, David Dowsett, Global Head of Investments, discusses the latest market developments, including excessive volatility in the Treasury market, the continued move higher in energy prices and the outperformance of the US dollar.

14 July 2022

• Equity markets rose slightly over the past week. There is a sense that after a terrible first half of the year, investors are pausing for breath and we are also seeing some reallocation from a flow perspective into equities. However, we should not read too much into this as beneath the surface, uncertainty persists. The first place to evidence this is the US Treasury market which had rallied but stronger US data released on Friday led to the reversal of those gains, bringing the 10-year Treasury yield above 3%. This illustrates the bind the market finds itself in the sense that seemingly good news leads to a sell-off in the Treasury market and acts as a reminder that the Federal Reserve (Fed) is far from done in terms of hiking interest rates. Ultimately, this leads to renewed uncertainly in relation to the prospects for risk assets and this is very difficult for investors to escape at the moment.


• We are witnessing excessive volatility in the Treasury market at present. The Move, which is the Treasury equivalent of the VIX, reached a level above 150 for only the 11th time in the last 35 years. It is notable that since the pandemic, the Treasury market has grown by approximately 50% as a result of additional issuance. It is very difficult for investment banks to process that risk, particularly against a backdrop of quantitative tightening whereby the central bank will not provide a liquidity buffer. In our view, we should expect higher volatility in the Treasury market to be a constant for the rest of the year. We believe the moves back and forth we have seen in the recent weeks will be the rule rather than the exception.


• Over the last week, we have also witnessed the continued move higher in energy prices in Europe. Gas prices are another 15% higher week-on-week while German electricity prices are 20% higher at the wholesale level week-on-week. This clearly reflects uncertainty around Nord Stream and when it will come back online. We now know that one of the important turbines, which will power the pipeline, has been released from Canada, but this unusual situation serves to demonstrate Europe’s acute vulnerability to higher energy prices. Recent research released by JP Morgan suggests current gas prices would lead to a 2% subtraction on an annualised basis from European growth in the second half of this year. This needs to be continually monitored.


• Policymakers, and particularly governments, are currently struggling to respond to the energy threat. In California, the governor has issued cheques to individuals to try to address the surtax on gasoline prices, which results in prices being USD 1.5 higher there than in the rest of the US. This is evidence of the increasing fiscal cost that we will have to deal with. In the UK, nearly all potential successors to Prime Minister Boris Johnson are proposing unfunded tax cuts. These do not make sense from an economic perspective and are indicative of the challenges the energy crisis poses to policymakers. In that respect, we saw the nationalisation of the remainder of EDF in France, also in a bid to try to cope with the energy crisis. These developments do not have to affect equity markets today but they demonstrate the overall challenges we are faced with.


• Also notable is the continued outperformance of the dollar; USD-EUR reached parity for the first time in two decades earlier this week. This is not occurring in a disorderly fashion but it nevertheless creates greater uncertainty, particularly given the high level of USD indebtedness around the world, namely in the emerging markets. It is important that the threat the strong USD poses to repayment is continually monitored. This is indicative of the immense challenges the world faces at the moment which are being processed through financial markets.


• Earlier this week, we saw US CPI accelerate to 9.1%, exceeding forecasts. Following on from that, the University of Michigan inflation expectations number will be released on Friday, which was formerly a key signal for the Fed to move rates by 75 basis points. Consensus seems to be that headline numbers will continue to go higher rather than fall. Beyond that, US banks will begin to release their earnings on Thursday. It will be important to see, on a single company level, the impact of macro developments and market trends.