Coffee Break 4/4/2022

LAST WEEK IN A NUTSHELL

  • First estimates for March consumer prices came in above expectations in Spain, Germany and France, mainly driven by energy prices. With an inflation rate at 7.5% in the euro zone, pressure is mounting ahead of the ECB meeting.
  • For the first time in 2 years, China’s manufacturing and services sectors simultaneously contracted in March, challenged by a COVID-19 resurgence. Shanghai, the commercial capital, is on lockdown.
  • The price of oil dropped as the US announced the release of a million reserve barrels a day for 6 months. Meanwhile, OPEC+ countries decided to ignore pressure from the West to accelerate an output rise.
  • The US economy created 431K jobs, while the ISM Manufacturing PMI slipped to a still strong 57.1, confirming the Federal Reserve’s assessment of a tight labour market and a strong economy.

 

WHAT’S NEXT?

  • The minutes from the last FOMC will be released. Investors will be eager to get more details on the monetary policy path, especially the balance sheet reduction aka quantitative tightening.
  • The ECB is also due to release similar minutes in a context of higher and longer-lasting inflation shedding some light on its timeline.
  • Japan’s consumer confidence is expected as the country is stuck between higher material cost (also due to the Ukraine crisis) and slowing Chinese growth.
  • Last but not least, we will keep hoping for a de-escalation of the war in Ukraine and will expect that geopolitics will remain in focus.

INVESTMENT CONVICTIONS

  • Core scenario
    • The Russian military invasion of Ukraine is leading to significant tensions and altering the market outlook over the medium term. For now, a scenario of a decent economic growth remains achievable, but time is of the essence: numbers’ range is decreasing as the conflict is lasting.
    • The Fed started a new hiking cycle in March and plans to accelerate tightening this year and continue next year. In our central - and best case - scenario, the Fed succeeds in soft landing the economy. We expect the rise in the US 10Y rates to fade going forward.
    • In Europe, the ECB put an end to its Pandemic Emergency Purchase Programme and announced it will stop buying bonds this summer. In a context of uncomfortably high inflation, this paves the way for an increase in interest rates.
  • Risks
    • The Russia-Ukraine war is pushing commodity prices in general and prices for oil and gas in particular, and continue to add to market uncertainty.
    • As currently visible in China, the COVID-19 and its variants underline the risk of a stop-and-go in economic restrictions.
    • The supply shock due to geopolitical tensions may weigh on activity and corporate earnings growth.
    • By the same token, a brutal, faster-than-anticipated rate tightening - if inflationary pressures increase further or simply persist at current levels- could jeopardize the recovery.


RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

The most immediate economic impact of the war in Ukraine is an upward revision in inflation forecasts for this year and a downward revision in GDP growth forecasts to 3.4% for the euro zone in our central scenario estimates. Therefore, uncertainties, already on the rise due to the accelerating monetary policy tightening in the United States, have risen further. The invasion of Ukraine and the subsequent economic sanctions on Russia have caused us to be prudent in our allocations. The longer the conflict lasts, the more vulnerable the world economy becomes through a negative feedback loop. This has led us to position our portfolios in a broadly balanced way. Our Multi Asset strategy must cope with the new uncertainties and remain nimble. The sharp rise in bond yields during the month of March led us to slightly reduce our underweight duration stance on both sides of the Atlantic.

 

CROSS ASSET STRATEGY

  1. Facing a binary outcome, we have positioned our portfolios around the neutral weight with some derivatives exposure in the euro zone and in the US. Beyond some specific segments such as European cyclicals, markets are not pricing an alternative, recessionary, scenario on equities and credit.
  2. We have an overall neutral positioning on equities with a focus on:
    • defensive sectors and quality stocks among healthcare, materials, energy and climate segments,
    • assets set to benefit from the sizeable bond issuance for energy and defence spending in the EU.
    We remain overweight Emerging market equities, due to an attractive valuation and support from rising commodity prices and more accommodation on China.
  3. In the fixed income universe, our strategy evolves along with the context:
    • We somewhat reduced our US and EU underweight duration, following the sharp rise in bond yields in recent weeks.
    • We also took some profit on our exposure to Chinese debt.
    • We keep a diversification via inflation-linked bonds and source of carry via emerging debt.
  4. In our long-term thematics and trends allocation: The Russian invasion of Ukraine has started to shift governments’ spending priorities in terms of energy independence and defence. Hence, while keeping a wide spectrum of long-term convictions, we will favour Climate Action (linked to the energy shift) and keep Health Care, Innovation, Demographic Evolution and Consumption.
  5. In our currency strategy, we have some exposure to NOK, CHF and JPY.

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