Inflation/Deflation

April’s CPI report was soft enough to justify a Fed pause in June. However, the overall economic data still don’t justify the magnitude of rate cuts priced into the yield curve.

There is a 50:50 chance of experiencing a major deflationary shock in the next two years, and an even greater likelihood on a longer timeframe. The good news is that several assets provide a good insurance against this risk, and that this insurance is now cheap. Plus we highlight a compelling commodity pair-trade.

If the recession begins this year, it is unlikely to be mild, because inflation will not have fallen by enough to allow the Fed to cut rates aggressively. In contrast, if the recession starts in 2024 or later, when inflation is likely to be much lower, the Fed will be able to cushion the blow. Our base case remains a 2024 recession but the risks around that view have increased in light of recent banking stresses.

Indian EPS growth is set for major disappointments vis-à-vis the lofty expectations. Weak domestic demand amid tight fiscal and monetary policy entails more downside in stock prices. Stay underweight.

Pent-up demand for services is keeping the global economy going, but we still expect recession over the next 12 months. Investors should keep a cautious portfolio stance.

EUR/USD is trying to breach above 1.10. What is the balance of positive versus negative factors that would allow the euro to breakout?

Yen bulls need patience. The near-term narrative remains bearish on the back of interest-rate differentials. Longer term, it is the most attractive currency the G10, on valuation grounds.

Yen bulls need patience. The near-term narrative remains bearish on the back of interest-rate differentials. Longer term, it is the most attractive currency the G10, on valuation grounds.

In Section I, we discuss why the rally in stock prices over the past month reflects the soft-landing view, and why that is not a likely economic outcome. US inflation is slowing, but target inflation remains elusive. Meanwhile, cracks in the US labor market are already apparent, and there is strong evidence against the view that US stocks are appropriately priced for an eventual US recession. This underscores that conservative investment positioning is still warranted. In Section II, we check in on the indebtedness risk of several major economies, and examine whether these risks exist primarily in the household, nonfinancial corporate, or government sectors. While there are limited cyclical implications of recent trends in global indebtedness, there are several problems that will eventually “come home to roost” – particularly in the US and China.

The dollar has entered a structural bear market. Although the greenback could get a temporary reprieve during the next recession, investors should position for a weaker dollar over the long haul.