Last week in a nutshell
- The labour market continued to be a bright spot for the U.S. economy with the latest addition of 390K non-farm payrolls. In addition, average hourly earnings increased by 5.2%, adding to the evidence that inflation may have peaked in March.
- Speaking about inflation, euro zone CPI estimates for May rose to 8.1%, above forecasts of 7.7%. This number added further pressure on the European Central Bank to communicate and act.
- The Bank of Canada raised its benchmark interest rate by half a percentage point to 1.5%. The central bank’s objective is to reach a neutral range of 2 to 3% but pace must be defined.
- China started to ease its COVID-19-related lockdown measures as the number of new infections has come down.
What’s next?
- Until recently, central banks policies have largely been supportive and predictable. But recent multiple shocks have led to multiple policy responses. This week, central banks meetings will unfold in the euro zone, Australia, Thailand, and India.
- Recent data confirm that inflation has likely peaked in the USA. A series of inflation data, particularly CPI and consumer inflation expectations in the Michigan consumer sentiment survey, will be in focus ahead of the FOMC on June 12.
- China will release services PMI and inflation data alongside trade numbers and aggregate financing data for May. They will be closely analysed as the virus situation showed early signs of improvements midway into the second quarter.
- Finally, flash euro zone Q1 GDP figures as well as final employment change data are lined up for release this week.
Investment convictions
Core scenario
- While the market environment still appears constrained by deteriorating fundamentals, more stability has appeared recently as a lot of pessimism has already been priced into markets.
- The reasons for a balanced allocation have not changed in recent weeks: The risks we previously outlined are starting to materialize, and are now part of the scenario.
- Facing high inflation, central bank rhetoric and policy tools have triggered a tightening in financial conditions while the global economic slowdown is now well underway as the war in Ukraine and the COVID-19-related lockdowns in China weigh on confidence and activity. The latter should pick up during H2.
- 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 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 sooner rather than later.
Risks
- Other countries may face the Bank of England (BoE) stagflation dilemma: Even as the growth outlook deteriorates sharply, 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. European gas prices are at the mercy of flows staying open.
- 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
Economic growth has slowed down and inflation has risen significantly, following multiple shocks. This represents a formidable business cycle accelerator. Our medium term outlook is cautiously optimistic for a gradual recovery once the landing is absorbed. In this context, our Multi Asset strategy is positioned to cope with “fat and flat” price ranges or “wide and volatile” markets. We keep an overall broadly balanced approach before position for the next stage of the cycle. The strategy added exposure to euro zone and US equities at the margin after the sharp correction. We maintain protective strategies on US markets and have positioned ourselves for potential upside in the euro zone via derivatives.
Cross asset strategy
- Our multi-asset strategy is staying agile. Our current positioning stays by nature more tactical than usual and can be adapted quickly:
- Neutral euro zone equities, with a preference for the Consumer Staples sector, and with a derivative strategy in place to catch the asymmetric upside potential
- 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 and with a derivative protection strategy.
- 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 have a close-to-neutral US duration via the short-end of the curve. We are still underweight euro zone duration.
- 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.
