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Fear of Inflation

The increase in inflation has been considered as one reason for the correction. Accelerating inflation is related to the tightening of central banks’ monetary policy and the rise in the interest rate level, which may be a burden on economies and equity markets.

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Sudden stop on equity markets

Equity market nerves reached their peak on February 8 after the global equity markets plummeted around ten percent in the space of a few days and volatility rose to 37 percent measured on the VIX Index. After a long period of steadily rising equity markets and extremely low volatility the markets were given a rude awakening. However, no individual piece of news or reason could be found to explain the violent movement and the markets’ uncertainty was not reflected in the real economy, so after the slight hesitation, the equity markets started on a new rise.

By the end of February most of the markets had regained more than half of what they had lost at start of the month with an upward correction. The European stock markets made the weakest recovery and the MSCI Europe Index remained four percent negative in February. When measured on the MSCI Index in euros, North American equities remained two percent negative and emerging market equities were 2.7 percent negative. Finnish equities weathered the storm better and the OMX Helsinki CAP GI Index ended up 2.3 percent positive.

On the fixed income markets the movements remained small. The decline in the values of the riskier corporate bonds was less than one might have expected from an equity market drop. The values of global high yield corporate bonds declined one percent measured on the ICE BofAML Index.

Fear of accelerating inflation in the background

The increase in inflation has been considered as one reason for the correction. Accelerating inflation is related to the tightening of central banks’ monetary policy and the rise in the interest rate level, which may be a burden on economies and equity markets. In the USA, the federal budget and tax solutions added more fuel to inflation concerns. One consequence of the long-discussed budget is the growth in the federal debt. We immediately had a taster of the growth in federal debt when the US Treasury Department issued USD 258 billion in bonds during one week.

We are yet to see any unpleasant surprises in the indicators that track the inflation of the US economy, but the risk of accelerating inflation has clearly increased. The new Federal Reserve Chairman, Jerome Powell, also offered his views on inflation expectations at his first appearance before Congress. His speech was considered to be moderate, even though he did say that economic growth would speed up further and that the Fed would be required to prevent the overheating of the economy. Long rates continued to increase after all in the USA in February. The yield on the US 10-year government bond climbed 0.2 percentage points to 2.9 percent. The dollar stopped weakening and strengthened slightly against the euro to 1.22.

Uphill struggle for the European Central Bank

The ECB has remained tight-lipped regarding its intentions. However, in his speech, President of the ECB Mario Draghi predicted that euro area inflation might remain lower than expected as the economy is running at low capacity. In any case, as the spring progresses the ECB is expected to provide news about the tapering of its purchase programs and the interest policy outlook. Structural solutions directed at Europe and the euro area may also have an impact on the growth outlook for coming years. Industry and consumer outlooks dipped slightly in February but are still very positive.

Tomas Hildebrandt , March 15

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