Coffee Break 27.06.2022

LAST WEEK IN A NUTSHELL

  • US initial jobless claims, a real time indicator of the US economy, have been deteriorating since the end of March. Pointing at a cyclical deterioration, the jobless claims have risen faster in typically manufacturing States of the South and Midwest parts of the US.
  • Business confidence indicators for the euro zone, in addition to flash PMIs, for June revealed readings just short of the low hit in April 2020 when COVID-19 hit Europe for the first time. Surging inflation amid the effects of the war in Ukraine and renewed supply chain issues are weighing on confidence for both businesses and consumers.
  • In his testimony before Congress, Federal Reserve Chair Jerome Powell confirmed the Fed’s commitment to bring inflation back down and stated that the strong American economy was well positioned to handle tighter monetary policy.
  • On the geopolitical front, EU countries confirmed their endorsement of Ukraine and Moldova as official candidates to join the bloc’s 27 members. Although largely symbolic, as the process is lengthy and tortuous, it is a geopolitical victory for Ukraine.

WHAT’S NEXT?

  • As Central banks are tightening into an economic slowdown any growth outlook-related data on supply and demand will be relevant. In the US, investors will scrutinize supply-related ISM, durable goods and inventory data, on the demand side, the Conference Board’s consumer confidence, as well as personal income and spending.
  • In the euro zone, consumption and inflation will be in focus. The June CPI numbers for Germany, France, Italy and the euro zone are due and will be the last ones to be published before the ECB’s July meeting, expected to kick off the hiking path. Consumer confidence measures are also to be released.
  • As China started relaxing some COVID-19 containment measures in June, investors are eager to find out China's industrial data and final manufacturing PMIs for the month. The measures should also have brought some relief to global supply chains.
  • A policy panel gathering Chair Powell, President Lagarde and Governor Bailey at the European Central Bank's Forum on Central Banking will be a key event to watch.

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

  • 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.
  • 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.
  • 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, that we actively manage. 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 but via an overweight US duration and underweight European duration.

 

CROSS ASSET STRATEGY

  1. 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 an actively-managed derivative 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.
  2. 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.
  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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