Coffee Break 5/16/2022

LAST WEEK IN A NUTSHELL

Global inflation reached new highs and will remain at elevated levels for longer. US inflation reached 8.3% in April, slightly higher than expected, but below the previous month’s level. Inflation may be peaking but is unlikely to come close to the Fed’s target anytime soon.
ECB President Christine Lagarde highlighted the challenge triggered by the war in Ukraine as it is hindering growth rates and fuelling inflation. Investors expect a first rate increase in July, followed by two additional 25bp steps this year.
Economic sentiment in the euro zone recovered somewhat from the Ukraine-war related drop in March but remains in negative territory. Meanwhile, US preliminary data hints at crosscurrents: the consumer is reassured by the strong labour market and rising wages but concerned by the high inflation and rising interest rates, both eroding its purchasing power.
China’s zero-COVID-19 lockdowns have hit business hard but authorities maintain their ambitious GDP growth target of 5.5% for this year. The most recent COVID-19 outbreak started 2 months ago and is forcing authorities to consider using earlier and/or even looser monetary and fiscal policy tools.

WHAT’S NEXT?

Industrial activity and consumption-related data will be published in China, Europe and in the US. The figures will show how resilient private demand remains amid the persistent high-inflation context.
In the US, housing market data will be in the spotlight. The NAHB housing market index, building permits, housing starts, and existing home sales will all be published in the coming days.
Fresh data on the euro zone labour market is expected. While the pandemic had created regional divergence between South and North, a broad recovery is on its way.
The People’s Bank of China, under mounting pressure to not only remain loose but also take more action to support economic growth, will release 1-year and 5-year loan prime rates.

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 in 2022 in the euro zone. European gas prices are at the mercy of flows staying open.
Facing multi-decade high inflation, the Fed started its hiking cycle in March and plans to add further 100bps to its funds rate by end-July and continue tightening thereafter. 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 at record highs, hitting businesses, consumers, and ECB policymakers alike. The ECB puts 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 sooner rather than later.
The supply shock due to geopolitical tensions weighs on activity and corporate earnings growth. In the US, input cost pressure continues too, via rising wages.

Risks

Other countries may face the Bank of England (BoE) stagflation dilemma: even as the growth outlook deteriorates sharply, the labour market could be tighter-for-longer while signs of upward pressure on inflation expectations, near-term wage and price setting behaviours remain.
A brutal, faster-than-anticipated rate tightening - if inflationary pressures increase further or simply persist at current levels- could jeopardize any soft landing.
The war in Ukraine is pushing upwards commodity prices in general and prices for oil and gas in particular and continue to add to markets uncertainties.
As currently visible in China, COVID-19 and its variants underline the risk of a stop-and-go in economic restrictions.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

Exiting the pandemic in the West, COVID-19-related lockdowns in China, the war in Ukraine and tightening monetary policies around the globe are acting together as a formidable business cycle accelerator. The various shocks registered over the past weeks have modified – and, to some extent, clarified – the market’s assessment. Our Multi Asset strategy is taking into account the acceleration towards end-cycle and continues to adjust gradually. While we will maintain a degree of caution, we are tactically adding exposure to US and euro zone equities as market sentiment is increasingly pessimistic. After the difficult start into the year, the markets could temporarily stabilise. Hence, we will aim for an overall neutral positioning. We continue to positively assess commodities, including gold, defensive sectors such as healthcare and consumer staples. The strategy also has a longer fixed income duration than at the start of the year but remains underweight.

CROSS ASSET STRATEGY

Our multi-asset strategy is staying agile, adding exposure to euro zone and US equities after the sharp correction and as our analysis indicates we are entering a stabilisation phase. Our current positioning stays by nature more tactical than usual and can be adapted quickly:
- Neutral euro zone equities, with a preference for the defensive Consumer Staples sector
- Neutral UK equities, resilient segments, and global exposure
- Neutral US equities, as the Fed’s rate hike has now been absorbed to an extent by the market.
- Neutral Emerging markets, with a preference for domestic China
- Neutral Japanese equities, as accommodative central bank, and cyclical sector exposure act as opposite forces for investor attractiveness
- With some exposure to commodities, including gold.
In the fixed income universe, a longer fixed income duration appears increasingly attractive as we register downward revisions in growth, highs in inflation expectations and strong central bank rhetoric regarding the willingness to tighten and fight inflation.
- We added some US duration via the short-end of the curve.
- We continue to diversify and source the carry via emerging debt.
In our long-term thematics and trends allocation: 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.
In our currency strategy, we are positive on commodity currencies:
- We are long CAD.