The first half of 2022 was marked by Russia’s invasion of Ukraine, geopolitical uncertainties, persistent inflation, soaring energy prices and central banks around the world tightening monetary policy. Faced with such a situation of uncertainty, we wonder whether this summer will see more such events that could disrupt financial markets. We asked experts from international asset managers Edmond de Rothschild AM, Generali Investments, Ostrum AM and Schroders for their views.
Benjamin Melman, Global CIO Edmond at Rothschild AM
The coming months will determine what interest rate levels markets should expect to see from monetary tightening. In the meantime, markets will remain under pressure. Were inflation to start falling rapidly, it would be easier for investors to chart the rate hike cycle and wait to see how inflation behaves.
That would be a more favourable scenario for investors as they might hope central banks could limit the risk of tipping economies into recession.
If not, current inflation levels and signs that household inflation expectations are de-anchoring, could very well make markets expect more rate hikes.
There are others who think central banks will stop tightening at the halfway stage to avoid a more moderate version of the 1970s’ recession and/or financial conditions. In other words, central banks would end up accepting inflation that is trending above their target levels.
Central banks today find it easier to deliver more hawkish messages because of persistent labour market tensions.
The fact that central banks are late in the tightening cycle has never been more obvious. However, the risks are high as we can easily imagine dire scenarios where central banks are either too lax, or so restrictive that they trigger a financial market crash. They will have to be very nimble to reach their targets without causing too much damage. The good news is that they are catching up and despite today’s turbulent geopolitical and market environment, the global economy is down but not out.
Economies in the West are slowing but China should pick up. Disinflation might possibly be just ahead. In recent weeks, commodity prices have all been falling back significantly now that markets are worried about growth. And, despite shortages, some sectors have perhaps overstocked so deliveries could be facilitated and downward pressure on prices might begin.
Matteo Cazzini, Senior Fixed Income Manager at Generali Investments
In the first half of the year several macro risks resurfaced on the markets with a clear regime shifting from QE to QT. This is going to be reflected during summer, exacerbated by seasonal factor as low liquidity on all asset classes. In addition, new catalysts are approaching the investors’ mind, in a circular way, with a sort of self-reinforcing scheme.
Inflation is persistent with possible upside surprises. If in US the peak could be by the end of the summer, this could not happen in Europe, due to war shocks and Covid effects.
Recent weakness of Euro versus Dollar is an additional negative factor to import “bad” inflation.
To fight this inflation, less transitory or entrenched, all major CBs turned hawkish. During summer this trend should go-on, with “hawks” more vocal than “doves” and after several years, in September, we should see ECB depo rate again back to zero/in positive territory.
The mix of higher inflation, upward rates and macro tension deriving from the Ukrainian conflict are weighting on risk sentiment with market indicators starting to fully price-in recession fears.
Rates curves should stay flat or even inverted; credit spreads, that moved wider with dispersion and decompression, could stay in a limbo and, in this context, the dollar seems the winner versus other currencies. Indeed, macro hedges will continue to play an important role.
In a nutshell, a lot of challenges for economy are already priced-in but we discovered that probability of tail risks is becoming bigger. Valuations are compelling but not stretched, with further room to go; the illiquid summer could be the excuse to trigger a final leg down for risky assets.
If recession will come in autumn, and central banks will be forced to put on hold the rates path, they could be attempted to overreact during the summer.
Philippe Waechter, Chief Economist at Ostrum AM
The first point of the summer will be the rise in ECB interest rates on 21 July. The associated message will be important. Since the ECB seminar in Sintra, expectations on monetary policy have been downgraded by investors.
The central bank is caught between the strong rise in inflation (8.6% in June) and the strong risk of recession resulting from the significant losses in consumer purchasing power but also from questions about Europe’s supply of Russian gas.
The ECB seemed hesitant, and no one expects it to be as proactive in its fight against inflation as it was a few months ago. This is a real source of fragility for the euro.
The second point is the risk of a technical recession in the US. The GDP of the first quarter had been negative at -1.6% in annualized rate. Estimates from the Atlanta Fed model, which takes into account the data actually published for the quarter, suggest a contraction in activity of -1.5% in mid-July over the spring months. This figure will be known on July 28. The Fed is due to meet on 26 and 27 July and is expected to raise the Fed Fund rate by 75 basis points again. This could lead to a complex situation to manage.
Activity figures for developed countries will also be available at the end of July in Europe.
The third point is the implication of the heat wave on government behavior and policies. Europe has suffered an unprecedented heat wave, and this can help raise awareness of the issue of climate change. Every European can and must understand the need to alter his behavior in order to take into account the efforts to maintain a sustainable climate situation over the long term. This will then facilitate the implementation of the policies necessary for convergence towards carbon neutrality. This summer of upheaval may be the beginning of a watershed.
Emma Stevenson, Equities Correspondent de Schroders
After a difficult quarter, in which much of the world’s equity indices have fallen into bear territory (defined as a fall of 20% or more), we take a look at the outlook for the third quarter. What has been driving stock prices? Are they currently expensive or cheap? And which regions and sectors are poised to do better in the coming months?
Global equities fell in Q2, extending year-to-date declines. The MSCI World Index returned -16.2% in Q2, taking the YTD fall to -20.5%.
The market backdrop remained dominated by concerns over higher inflation, rising interest rates and the risk of recession, as well as the war in Ukraine.
Many stock market indices have entered a bear market, defined as a fall of 20% or more.
UK equities remain the top performing market this year, as rising commodity prices continue to boost energy company revenues.
Given the increase in earnings, UK valuations look cheap relative to their own history and their regional peers on a forward P/E basis.
Japanese shares look attractive on several valuation metrics. At the same time, the yen has been weak which typically benefits Japan’s exporters. This could lead investors to reconsider their view of Japanese stocks.
In recent months, defensive stocks have seen their valuations versus cyclicals re-rate significantly as investors look to trim their exposure to risky, economically-sensitive companies.
Globally, value stocks continue to outperform growth. Much of the rotation reflects the sharp de-rating of expensive tech or consumer companies, whose valuations are sensitive to high interest rates and whose share prices had baked in very high growth expectations.