Coffee Break 5/9/2022

LAST WEEK IN A NUTSHELL 

  • In the US, the Federal Reserve Bank hiked its funds rate by 50bps, the biggest hike since 2000 and announced it should start a balance sheet reduction in June. Chairman Jerome Powell confirmed that additional tightening measures are on the table (50bps) for the next couple of meetings.
  • The US job report confirmed the creation of 428K non-farm payrolls. Average hourly wages in April were 5.5% higher than a year ago while the unemployment rate remained stable at 3.6%. Employment registered a drop of 353k – its first decline since April 2020.
  • The GBP hit a low against the USD in the aftermath of a 25bps rate hike and a dire outlook by the Bank of England.
  • Global PMIs for April slowed somewhat in the face of the war in Ukraine. Service activity resisted well as virus containment measures were relaxed further. Firms are however facing soaring costs and are passing some of that burden onto consumers.

WHAT’S NEXT?

  • Inflation will be one of the key focus points with data released in key countries including the US and China.
  • China will also release data on trade, giving us additional cues on how recent COVID-19 social distancing measures in mainland China have impacted economic growth.
  • Preliminary data on economic sentiment in the euro zone and the US will help us gauge how households and corporates are assessing the state of the economy.
  • On the geopolitical front, investors will follow Victory Day in remembrance of the end of WWII, traditionally marked by a military parade and a President's speech in Russia, a special US-ASEAN Summit in Washington and if Finland and Sweden decide whether to apply for NATO membership.

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. A cut in natural gas delivery from Russia would however represent a major downside risk for growth.
  • 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. We further reduced our overall exposure to equities. We trimmed our exposure to the euro zone, the UK and the emerging markets. We continue to positively assess commodities, including gold, defensive sectors such as healthcare and consumer staples. The strategy has a longer fixed income duration than at the start of the year but remains underweight.

 

CROSS ASSET STRATEGY

  1. Our multi-asset strategy is adjusting further: our cautious view on equities leads us to sell the rally, in line with a slight underweight assessment on equities. As equity markets remain extremely volatile, our current positioning is by nature more tactical than usual and can be adapted quickly after a more significant correction and by observing the deterioration of market sentiment, which would trigger a potential contrarian signal:
    • Underweight euro zone equities, with a preference for the domestic Consumer Staples sector
    • Neutral UK equities, resilient segment, and global exposure
    • Underweight US equities as we see growth stock valuations at risk in a context of rising inflation and rates.
    • Neutral Emerging markets, with a preference for China and Latin America
    • 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.
  2. In the fixed income universe, a longer fixed income duration appears increasingly attractive as we register downward revisions in growth, new highs in inflation expectations and strong central bank rhetoric regarding the willingness to tighten and fight inflation.
    • We continue to diversify and source the carry via emerging debt.
  3. 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.
  4. In our currency strategy, we are positive on commodity currencies:
    • We are long CAD.
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