Europe
Older workers have deserted the labour force in the US and the UK, but not so in the Euro area and Japan. The result is that wage inflation is red hot in the US and the UK, but not so in the Euro area and Japan. Hence, the Bank of Japan is right to remain a lone dove, the ECB must pivot from its uber-hawkish stance quite soon, but the Fed and the BoE must not pivot from their uber-hawkish stance too soon. We go through the major investment implications.
This week’s report examines the state of the global monetary tightening cycle and addresses some frequently asked questions about the Fed’s QT program. New yield curve trades are recommended for the US and German yield curves.
Stay short Greater China assets. Stay long Japanese yen. Hold back on Brazil for now but look forward to opportunities in future.
The ECB increased interest rates and announced the start of its balance sheet wind down; yet, markets took the news as a dovish outcome. Are we really getting close to the end of the ECB’s tightening campaign? How asset prices will react?
Falling inflation will allow bond yields to decline in the major economies over the next few quarters. As such, we recommend that investors shift their duration stance from underweight to neutral over a 12 month-and-longer horizon and to overweight over a 6-month horizon. Structurally, however, a depletion of the global savings glut could put upward pressure on yields.
Despite uncertainty and intrusive government policy, natural gas and oil markets have managed to direct much-needed supplies to Europe going into winter. Natgas markets attracted massive LNG inflows – at a cost of record-high prices – that now leave the continent’s on-land storage close to full. A floating LNG market now exists on Europe’s Atlantic Coast – made possible by spot prices at the Dutch Title Transfer Facility trading ~ 40% below 1Q23 futures. The TTF futures contango market structure allows unsold cargoes to be stored on vessels off the coast of Europe until needed this winter via hedging (e.g., buy spot, sell 2- to 3-month-forward futures to lock in storage costs). This expands storage for the continent, leaving the EU in much better shape to weather the loss of Russian pipeline gas.
In Section I, we note that while recent inflation developments point to some supply-side and pandemic-related disinflation, they also point to potentially stickier inflation over the coming several months. The inflation, monetary policy, and geopolitical outlook remains sufficiently risky that an overweight stance towards equities within a global multi-asset portfolio is not justified, and we continue to recommend a neutral stance for now. This month’s Section II is a guest piece written by Martin Barnes. Martin, who retired from BCA Research as Chief Economist last year after a long and illustrious career, discusses the outlook for government debt and the possibility of an eventual crisis.
It takes time for wage inflation to die. So, if 2022 was the year that central banks’ monster tightening killed bond and stock market valuations, then 2023 will be the year that it finally reaches the economy and kills profits, jobs, and the wage inflation that has so far refused to die. This means that commodity prices have substantial further downside, while healthcare relative performance has substantial further upside.