Coffee Break 4/25/2022

LAST WEEK IN A NUTSHELL

  • The annual inflation rate in the euro zone came out at +7.4% in March (vs 5.9% in February). The war in Ukraine and sanctions on Russia pushed fuel and natural gas prices to record levels.
  • Federal Reserve Chairman Jerome Powell confirmed the central bank is ready to raise rates expeditiously.
  • The US and the German 10-year Treasury yields spiked recently amid concerns around inflation, more aggressive stance by major central banks on future interest rate increases, and their potential to weigh on economic growth.
  • China’s Q1 GDP grew by 1.3% q/q and 4.8% y/y but risk to the outlook rose sharply, leading the People’s Bank of China to cut the required reserve ratio by 25 bps. Balancing the economic growth while containing the current COVID-19 outbreaks has remained a challenge.

 

WHAT’S NEXT?

  • Having won France’s hotly contested presidential race, Emmanuel Macron will govern the 7th world’s economy for a second 5-year mandate. Legislative elections will take place in June.
  • The euro zone and the US will publish flash Q1 GDP growth rate shedding some light on how global growth has been faring so far. The IMF already cut global growth forecast and anticipate a fragmentation of the world economy into rival blocs.
  • Germany will release readings of the IFO business climate, current conditions and expectations whereas the country is moving as fast as possible to end its dependence on Russian energy.
  • Central banks will remain in focus even if the Fed will be in a blackout period ahead of the May 4th meeting. The Bank of Japan will meet and is expected to address the recent Yen weakness driven by its persistently more dovish stance.

INVESTMENT CONVICTIONS

  • Core scenario
    • Measures taken by governments and accumulated savings during the pandemic could help cushion the erosion of household purchasing power and allow GDP to grow by 2.9% in 2022 in the euro zone. A cut in natural gas delivery from Russia would however represent a major downside risk for growth.
    • The Fed started a new hiking cycle in March and plans to accelerate tightening this year and continue in 2023. 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, inflation is suddenly surging, hitting businesses, consumers, and ECB policymakers alike. The ECB put an end to its Pandemic Emergency Purchase Programme and announced it will stop buying bonds this summer. 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

Exiting the pandemic, entering the war and global tightening monetary policies act as a formidable business cycle accelerator. While at the turn of the year, the economic environment was challenging to assess because exiting a pandemic was unknown territory, the upcoming inflation peak seemed in shouting distance. The various shocks registered over the past weeks have modified – and, to some extent, clarified – the market’s assessment: The shocks have not fallen equally around the world and Europe appears the most vulnerable. Our Multi Asset strategy is adjusting. Our equity exposure remains broadly balanced, we are neutral US duration and still slightly underweight euro zone duration.

 

CROSS ASSET STRATEGY

  1. Our multi-asset strategy takes into account the acceleration towards end-cycle: We have reduced our equity exposure early-February and will stay overall neutral equities with nuances:
    • Neutral equity with some exposure to commodities, including gold.
    • Underweight US equities as we see growth stock valuations at risk in a context of rising inflation and rates.
    • Overweight Emerging markets, specifically via China (rebound of credit impulse) and Latin America (support from rising commodity prices).
  2. In the fixed income universe: In a context of fading growth, inflation expectations at highs and central banks willing to tighten, a longer fixed income duration appears increasingly attractive.
    • We are neutral on the US duration and slightly underweight euro zone duration.
    • We continue to diversify among inflation-linked bonds and source the carry via emerging debt.
  3. 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.
  4. In our currency strategy, we are positive on commodity currencies:
    • We are long CAD.


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