The second quarter of 2022 was when reality sank in.

The global investing regime has changed fundamentally, and for the foreseeable future. But it was in Q2 2022 that the Federal Reserve – the world’s most important central bank – finally moved decisively to tighten monetary policy and clarify that inflation fighting was paramount.

Markets plunged, leading to the biggest half year decline since 1962. Investors were gripped by alternating fears – of inflation and recession. Data releases added to the confusion, first indicating higher and more persistent inflation than expected, then suggesting an economic slowdown that could tip into recession as consumer and business sentiment fell, and then showing continued labor market strength and jobs growth. The energy crisis triggered by Russia’s invasion of Ukraine threatened a return to 1970s style stagflation, with a particularly devastating impact in Europe on both growth and inflation.

In the US, tightening monetary policy cast a shadow over equity markets, while reassuring those worried that the Federal Reserve and other major central banks had lost sight and control of inflation. The tech winners of the pandemic era of “low interest rates for longer” became the biggest losers. By the end of Q2, the outlook for fixed income investors had become brighter with interest rates having reset higher. However, we still expect volatility to remain elevated as central banks shift away from easy-money policies.

It will take some time for the contours of the new economic, financial, and geopolitical world to become clear. Already in Q3, there have been political upheavals in the UK and Italy. The resignation of Italian Prime Minister Mario Draghi is particularly concerning for the European outlook.

In the meantime, three key themes stand out for investors to watch in Q3: inflation, global slowdown, and a shift in trade patterns – notably of energy – that will have long-lasting impacts on growth, exchange rates, and geopolitical relationships.

Might we be headed back to the future, when inflation – and the fight to curb it – dominated the macro background? A slowdown is inevitably coming, in the US and elsewhere. The question is whether there will be a crash landing, or just a bumpy few months. Can the Fed, against the odds, succeed in cooling the economy sufficiently to bring down inflation without a sharp rise in unemployment?

Click here to read the RockCreek Q2 2022 Commentary Letter

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