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How will geopolitical tensions affect markets?

How will geopolitical tensions affect markets?

Investors started 2022 keenly focused on the trajectory of global monetary policy as inflation has surged across the world. While central banks are still a dominant theme in markets, traders must now also contend with deep uncertainty over how the situation on the Russia-Ukraine border will unfold.

Economists can at least attempt to predict the outcome of central bank decisions by building models based on data, commentary from officials and historical precedent. But the outcome of the stand-off between Russia and the west is a type of so-called tail risk that could have major implications for the global economy, yet cannot be easily or accurately modelled.

The sense of uncertainty has begun creeping into financial markets.

Volatility in the US government bond market, the bedrock of the global financial system, is running at its highest level since the market ructions early in the coronavirus crisis two years ago, as traders parse through headlines on the Russia-Ukraine situation and try to interpret the US Federal Reserve’s next moves to rein in inflation.

At the same time, equities markets have become more jittery, with the cost of buying protection against near-term swings on Wall Street rising higher.

However, Jim Reid, strategist at Deutsche Bank, noted that US stock sell-offs triggered by geopolitical events tended to be “shortlived . . . with a duration of around three weeks to reach a bottom and another three weeks to recovery from their prior levels”. The median during these periods of geopolitical angst are 5.7 per cent, Reid said. Adam Samson

Did the easing of Covid restrictions boost European business activity in February?

Falling Covid-19 infections and the easing of restrictions are expected to have boosted European activity in February, lifting the flash IHS purchasing managers’ indices for manufacturing and services.

Economists polled by Reuters forecast that the UK PMI composite index, a measure of the health of the private sector, will rise to 55 in February, from 54.2 in the previous month, when it is published on Monday.

Any reading above 50 indicates a majority of businesses reporting expansion.

“We expect that there was a further recovery in the services PMI in February, as economic activity was boosted by the lifting in plan B restrictions and Covid-19 infection numbers eased,” said Ellie Henderson, economist at Investec.

The UK manufacturing PMI index is expected to edge up in February following the easing of supply chain disruptions, while the services PMI is forecast to jump more than one point to 55.2 as workers returned to the office and to socialising. However, for both the manufacturing and services sectors, “concerns do remain with labour shortages limiting output and inflationary pressures threatening to squeeze household incomes”, said Henderson.

Line chart of Purchasing managers' index, reading below 50 represents a contraction showing Eurozone activity is expected to improve in February

Any stronger than expected PMI reading could support the view that the Bank of England will raise borrowing costs again at its March meeting, as it battles with the highest rate of inflation in 30 years.

The pace of expansion is expected to be marginally weaker in the eurozone, reflecting a delayed hit from the Omicron coronavirus wave compared with the UK. However, economists forecast the eurozone composite PMI to rise to 52.7 in January, from 52.3 in the previous month, following an acceleration in activity in both France and Germany, driven by stronger growth in their services sectors. Valentina Romei

Did the Fed’s preferred inflation measure hold near its 38-year high last month?

The rate of price increases in the US likely held near a 38-year high in January, based on the Federal Reserve’s preferred inflation measure, as central bank officials move closer to raising rates for the first time during the pandemic.

The core personal consumption expenditures (PCE) price index, which strips out volatile food and energy prices, is forecast to match the previous month’s gain at 0.5 per cent, according to economists polled by Bloomberg. That would bring the index to a 5.2 per cent rise over the past 12 months, up slightly from the 4.9 per cent increase seen in December that marked the largest such gain since September 1983.

The report from the Bureau of Economic Analysis on Friday is also expected to show a 0.6 per cent rebound in personal spending since December.

Kathy Bostjancic, chief US financial economist for Oxford Economics, predicted the annual increase in PCE prices is on track to remain above 3 per cent in the fourth quarter, which policymakers would consider “unacceptably high” at year-end.

The sharp rise in prices over the past year has heaped pressure on the Biden administration and the Fed to tame rampant inflation.

James Bullard, the St Louis Fed president and a voting member of the central bank’s policy committee, recently said he would support raising the benchmark rate by a full percentage point by the start of July — suggesting at least one half-point rise, something the Fed has not done since 2000.

Investors now place 52 per cent odds on the Fed pushing rates at least one point higher before the end of its June policy meeting, according to the CME’s FedWatch Tool. Matthew Rocco

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