Inflation has made the first half of 2022 the worst since 1970. Despite forecasts predicting this would happen, The Fed assumption that inflation was “transitory” has forced the economy to play catch up.

CNBC/Jeff Cox
This was the worst first half for the market in 50 years and it’s all because of one thing — inflation

A multitude of factors conspired to generate the stock market’s worst first-half since 1970, but they all emanated from one word: inflation.

The cost of living started the year running at levels the U.S. had not seen since the early 1980s.

Worse, Federal Reserve officials, armed with full-year forecasts of “transitory” inflation that now seem almost comically inaccurate, fell behind the curve, endangering a market and economy still fragile from the Covid pandemic.

Six months later, the damage has been severe if something short of catastrophic: An S&P 500 down nearly 20%, a symbol of how risk investing across the spectrum, from crypto to IPOs and even some areas of the commodities market, has collapsed.

“It was inflation. That’s the Fed’s nemesis,” said Quincy Krosby, chief equity strategist for LPL Financial. “It was the Fed staying with its ‘transitory’ mindset of inflation easing. … It was central bank largesse, it was government largesse. The Fed was surprised [about inflation] even just a few days before its last meeting. That’s how we got here.”

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Marketwatch/Nouriel Roubini
Stocks could drop 50%, Nouriel Roubini argues. Things will get much worse before they get better

The global financial and economic outlook for the year ahead has soured rapidly in recent months, with policy makers, investors, and households now asking how much they should revise their expectations, and for how long.

That depends on the answers to six questions.

First, will the rise in inflation in most advanced economies be temporary or more persistent? This debate has raged for the past year, but now it is largely settled: “Team Persistent” won, and “Team Transitory”—which previously included most central banks and fiscal authorities—must admit to having been mistaken.

The second question is whether the increase in inflation was driven more by excessive aggregate demand (loose monetary, credit, and fiscal policies) or by stagflationary negative aggregate supply shocks (including the initial COVID-19 lockdowns, supply-chain bottlenecks, a reduced labor supply, the impact of Russia’s war in Ukraine on commodity prices, and China’s “zero-COVID” policy).

While both demand and supply factors were in the mix, it is now widely recognized that supply factors have played an increasingly decisive role. This matters because supply-driven inflation is stagflationary and thus raises the risk of a hard landing (increased unemployment and potentially a recession) when monetary policy is tightened.

That leads directly to the third question: Will monetary-policy tightening FF00, -0.00% by the Federal Reserve and other major central banks bring a hard or soft landing? Until recently, most central banks and most of Wall Street occupied “Team Soft Landing.” But the consensus has rapidly shifted, with even Fed Chair Jerome Powell recognizing that a recession is possible, and that a soft landing will be “challenging.”

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CNBC/Holly Ellyatt
European stocks log worst quarter since the Covid outbreak as investors stress over inflation and rate hikes

European stocks closed down Thursday with all of the region’s major indexes slumping on the final trading day of the first half of the year.

The pan-European Stoxx 600 index closed 1.6% lower with all sectors in negative territory. Banks were lower by 2.8% as a banking supervisor in the euro zone asked lenders to assess their recession risks.

The benchmark index ended the second quarter of the year down 9% — the worst three-month period since the onset of the coronavirus pandemic in 2020. Year-to-date the index is down by 16.6%.

Swedish aerospace and defense company Saab was one of the best performers on the index. It was up 4% after it received a 7.3 billion Swedish crown ($713.9 million) order for two of its GlobalEye Airborne Early Warning and Control aircraft planned for delivery in 2027.

The worst performer was German energy company Uniper. Its shares were down a massive 14% after it withdrew its financial outlook for 2022 on Gazprom gas supply restrictions.

The company said it had received only 40% of the contractually agreed gas volumes from Gazprom since June 16 against the backdrop of war in Ukraine. It expects its adjusted earnings before interest and taxes and adjusted net income for the first half of 2022 to be significantly below last year’s levels.

Declines in Europe come as global market sentiment remains gloomy — there’s no prospect of the war in Ukraine ending anytime soon and inflationary pressures are likely to continue to build. With central banks looking to aggressively fight rising prices with interest rate hikes, there are growing fears of a global slowdown.

Data releases in Europe on Thursday included French preliminary inflation data for June which showed the country’s consumer price index rose by 5.8% from the year before, up from 5.2% in May, France’s INSEE statistics body said.

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