Last week in a nutshell
- Energy markets were again shaken as Russia reduced gas supplies to France, Germany and Italy just as their heads of Government visited Ukraine President Volodymyr Zelenskiy. It was the highest profile visit to the country since the Russian invasion in February. Prices surged, delaying yet again a possible return to a post-COVID-19 but pre-war situation.
- With an interest rate hike of 75bps, the US Federal Reserve Bank announced its biggest interest rate hike since 1994. Chairman Jerome Powell justified this move following the recent economic news on inflation (which hit a 40-year high). Other central banks were put under pressure to follow suit.
- The European Central Bank held an emergency meeting, highlighting the additional challenge the ECB is facing: The risk of fragmentation as weaker states are more vulnerable to surging borrowing costs and the end of the ECB’s debt-buying programme.
- Japan's seasonally adjusted real GDP dropped by 0.3% in April, the first contraction in three months. Exports were weaker than anticipated, primarily due to China’s lockdown which slowed production and sales activities in the country. In this context, the Bank of Japan confirmed its accommodative stance.
What’s next?
- Investors will watch the releases of home sales and preliminary PMI surveys figures in the US, following last week's stream of soft data in retail sales, the Philadelphia Fed survey, housing starts and building permits. All these milestones will be key to assess the spreading of the slowdown to other parts of the economy.
- On this side of the Atlantic, Business confidence indicators for France, Belgium and Germany will be released. In addition to flash PMIs for June, they will reveal important insight on the economic momentum at the end of Q2.
- Several central banks will meet and undoubtedly highlight the difficult tasks they are facing. Norway's Norges Bank, which was early to kick off the rate-hiking cycle last year, is expected to increase its rate again. In Turkey, the central bank must cool inflation in the 70%’s range and stabilise a sliding currency whereas in Mexico, Banxico is expected to follow the Fed and hike its benchmark rate by 75bps.
- Federal Reserve Chair Jerome Powell will testify before Congress to give his regular, semi-annual update, on monetary policy. A timely meeting following last week’s unusual 75bp rate hike.
- On the geopolitical front, an EU council meeting, which, will include Ukraine’s path to EU membership will be on the agenda. This will kick off a 2-week series of Western leaders' summits, including the G7 in Germany and the NATO Summit in Spain. Tensions with Russia are unlikely to cool down soon.
Investment convictions
Core scenario
- While the market environment still appears constrained by deteriorating fundamentals, markets have been shaken by the latest announcements by the Federal Reserve.
- Facing multi-decade high inflation, the Fed started its hiking cycle in March and plans to add further giant steps 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. As a result, we expect the rise in the US 10Y rates to fade going forward.
- Inflation is also at historical highs in the euro zone, hitting businesses, consumers, and ECB policymakers alike. The ECB pre-announced an initial rate hike for the month of July, and markets expect the announcement of new tools for periphery bond “fragmentation”.
- Facing high inflation, central bank policy tools have triggered a sharp tightening in financial conditions while the global economic slowdown is now well underway. The war in Ukraine and the COVID-19-related lockdowns in China weigh on confidence and activity. The latter should pick up during H2 in China as stimulus measures kick-in.
- The reasons for a balanced allocation have therefore not changed in recent weeks: The risks we previously outlined are starting to materialize and are now part of the scenario as the economy prepares for landing, whether it be soft or hard.
Risks
- A brutal, faster-than-anticipated rate tightening - if inflationary pressures increase further or simply persist at current levels- could jeopardize any soft landing.
- 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.
- The war in Ukraine is pushing upwards commodity prices in general and prices for energy in particular and continues to add to market uncertainties. European gas prices are at the mercy of flows staying open, or countries finding alternatives to the Russian supply.
- 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
The multiple shocks experienced so far in 2022 have led to a rare simultaneous decline in equity and bond values. Major central banks are tightening monetary policies and investors are preparing for the landing of the global economy. Our Multi Asset strategy is positioned to cope with the economic slowdown underway and is ready to shift gear depending on the unfolding economic sequence and central banks’ reaction. Our exposure keeps an overall broadly balanced allocation before positioning itself for the next stage of the cycle, may it be a soft or a hard landing. We have a neutral equity exposure, including derivatives. We keep some exposure to commodities, including gold. In our bond allocation, we consider the expected upcoming Federal Reserve policy path, the high inflation, the slowing growth, and the flattening of the yield curve. We are overall neutral duration, overweight US duration – after selling some short end notes and buying longer maturity notes - but underweight European duration.
Cross asset strategy
- Our multi-asset strategy is staying agile. Our current positioning stays more tactical than usual and can be adapted quickly in this highly volatile context:
- 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, with a derivative protection strategy, as we remain attentive to the Fed’s forward guidance.
- Neutral Emerging markets, because our assessment indicates an improvement, especially in China, both on the COVID-19 / lockdown and stimulus fronts during H2.
- 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, we acknowledge downward revisions in growth, highs in inflation expectations and strong central bank rhetoric regarding the willingness to tighten and fight inflation. We are neutral duration but with nuances:
- We are overweight US duration after buying longer-dated bonds and selling shorter maturity notes while we are still slightly underweight euro zone duration via French bonds.
- 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.
