Risk assets continued to fall in Q2, leading to most asset classes, with the notable exception of commodities, to experience significant losses for the year. Equity markets across the board are down significantly, with the S&P 500 entering bear market territory for the first time since March 2020, but the fall in value of fixed income is more significant for many investors. Fixed income indices have seen greater drawdowns, often by an order of magnitude, than ever before. Year to date, the MSCI World returned -21.2%, S&P 500 -20.6%, High Yield -13.8% and the Bloomberg Global Aggregate -13.9%.
The macro story is very much a continuation from late 2021 and early 2022. Inflation greatly exceeds targeted levels, this is creating pressures in the economy, and to bring down inflation central banks are increasing interest rates. This could well, even will likely, create a recession across most regions. Central banks do not want to create a recession, but reducing demand is the only way to tame inflation, which has clearly taken them by surprise. With inflation being so high and central banks having been behind the curve in looking to address the situation, the risk of a mistake is elevated. There is the potential for (1) raising interest rates too high and causing a deeper economic downturn than needed, and (2) stopping raising rates too soon, allowing inflation to take hold. Inflation in the 1970s actually came in a number of waves as the Fed pivoted too early when the cost of bringing down inflation, economic deterioration, became evident. Both these risks are present today.