investment insights
Paradigm shifts keep testing markets
Lombard Odier Private Bank
Equity markets rebounded after a difficult six months, supported by solid earnings and better news on US inflation. But the Federal Reserve’s fight against inflation is far from over, even if its path to restrictive territory may slow, starting in September.
We expect the Fed’s policy rates to peak at 3.75% in 2023. As higher borrowing costs trickle through the economy, we expect a mild recession in 2023. Strong labour markets are a key variable for the monetary policy outlook, and the risk of a more severe downturn cannot be ruled out if the Fed needs to act more forcefully in the face of persistent inflationary pressures.
In Europe, energy is top of everyone’s mind. Can the continent avoid a worsening energy crisis this winter? Gas prices will stay high, with a knock-on effect on inflation that will slow growth over the quarters ahead. Through the energy crisis, weak growth and political instability, the European Central Bank has started an interest-rate hiking cycle that we see peaking at 1.25% in early 2023.
In China, weaker economic momentum has pushed the government to boost growth, and we expect more support in the run-up to the policy-setting National People’s Congress. The key risks to the Chinese economy remain its zero-Covid policy, and the turbulent property sector.
Global growth is slowing as interest rates rise. The key question is, are we facing a hard or soft economic landing? The answer is largely in the outlook for inflation: some improvements are likely later this year as global supply chains normalise, and as US demand cools, but commodity markets remain dependent on the war in Ukraine.
Until inflation improves further, and recession risks fall, more market weakness is possible.
This is why our portfolio positioning is prudent. We continue to underweight equities, favouring quality stocks as they usually outperform in challenging markets. We also retain an underweight stance in fixed income, having reduced our exposures to government bonds. In commodities, we lowered our overweight. As risks shift from inflation to growth, commodities offer fewer diversification benefits. In currency markets, the US dollar and Swiss franc will continue to appreciate as global growth slows, while the euro and sterling face more weakness.
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