Inflation/Deflation

In this Strategy Outlook, we present the major investment themes and views we see playing out for the rest of 2023 and beyond.

In Section I, we discuss the implications of the banking crisis that emerged in March. We do not expect what happened in the US or Europe to morph into a full-blown meltdown of the financial system, but this month’s events will likely lead to a further tightening in bank lending standards, raising further the odds of a US recession over the coming year. We continue to recommend an underweight stance toward risky assets versus government bonds over the coming 6-12 months, and defensive positioning within a global equity portfolio. In Section II, we estimate the impact of recently-passed US legislation on US business investment over the structural horizon and conclude that it will indeed boost capex growth over the coming several years. Assets poised to benefit from this trend will likely underperform over the coming year but should be bottom-fished following the next recession.

CCP officials are discussing policy options for breaking out of a deepening liquidity trap. Anything policymakers come up with will be additive to existing spending and to the multi-trillion-dollar fiscal-stimulus packages being rolled out by the EU and US. Inflationary pressures in the real economy will become embedded as increasing demand for industrial commodities meets constrained supply. Stagflation likely follows.

US financial instability reinforces our bearish investment outlook by weighing on economic growth and corporate earnings while also increasing US policy uncertainty and geopolitical risk.

Systematically important central banks continue to compound policy errors, which will feed higher headline inflation. Hiking interest rates to induce labor-market slack – i.e., higher unemployment – to bring down core inflation will reduce demand for scarce commodities as incomes fall. It also will increase the cost of conventional and renewable capex and slow the final-investment-decision (FID) process. Net, supply will tighten as demand is squeezed. This will resolve itself in higher volatility and prices. Separately, we were stopped out of our XOP and XME ETFs spanning energy and mining equities, respectively, with a loss of 11.9% and a gain of 4.4%. We will be re-establishing these exposures at tonight’s close.

The Bank of Japan is about to get new leadership when Kazuo Ueda takes over as governor in April. Will there be a new monetary policy to go along with the new governor? We attempt to answer that question, and what that means for global bond markets and the yen, in this Special Report.

Bank failures are another ‘canary in the coal mine’ warning that a US recession is imminent, yet stocks, bonds, and the oil price are still a long way from fully pricing it.

The growth and inflation profiles of the three central European countries are set to diverge. The outlook for Polish and Hungarian Bonds are not attractive anymore. Book profits on them. Instead, initiate a new trade: pay Polish / receive Czech 10-year swap rates.

The UK economy is more resilient than was feared last year. While this will not help UK stocks, the Footsie’s long term prospects are appealing.

Investors in Europe and the American West are already starting to think about the implications of the 2024 election, given that sticky inflation and tighter monetary policy keep the risk of recession elevated.