Inflation/Deflation

There are several widespread market narratives regarding US inflation, the Fed’s policy, global manufacturing/trade and China’s recovery that we disagree with. In this report, we explain our reasoning and where it puts us in terms of investment strategies.

No, the secular rise in geopolitical risk has not peaked. EU-China trade ties underscore the multipolar context, but this multipolarity is unbalanced, as the US has not reached a new equilibrium with its rivals. While the second quarter is murky, investors should stay defensive this year on the whole.

Today’s releases of the March CPI and March FOMC minutes do not change our view that the Fed will deliver one more 25 basis point rate increase before going on hold.

Through February and March, the number of US ‘job losers’ surged by almost half a million. Constituting the largest two-month increase in Americans who have lost their job since the depth of the pandemic. Unless we see a big drop in the number of job losers in the coming months, the correct investment strategy is still to position for a US recession that starts in 2023.

In this report, we present our performance review of the BCA Research Global Fixed Income Strategy (GFIS) model bond portfolio for the Q1/2023, and the outlook and scenario analysis for the next six months. The portfolio slightly underperformed its benchmark during the quarter as global growth showed surprising resilience to begin the year. Looking ahead, the portfolio is positioned to capitalize on an expected slowing of global growth over the rest of the year through an overweight stance on government bonds versus spread product.

Several signs have emerged that the “bad news is good news” rally has run its course. Despite deteriorating economic data, the Fed is expected to maintain its “higher for longer” stance, disappointing the market. A rate cut is likely is only in case of a severe downturn, but that will not offer support to equities, until earnings growth bottoms. We recommend shifting a portfolio toward a defensive stance, and away from cyclicals at this juncture. We downgrade Auto to an underweight, and Capital Goods and Energy Equipment and Services to an equal weight.

European inflation has further downside and core CPI will soon begin to fall too. However, European growth will remain soggy in Q2. What does this environment mean for investors?

Is there a lot of cash on the sidelines ready to be deployed? Would the US recession not be bearish for the US dollar and help EM like it did in the early 2000s? Why can the US investment playbook of the past 15-25 years not be used in this cycle?

In this <i>Special Report</i>, BCA Strategist Ritika Mankar highlights that Japanese savers own foreign assets to the tune of a staggering $6.5 trillion today. As implausible as it may seem today, the rate cycle in Japan will turn later this decade. Once it does, Japanese savers will sell down their global assets – a dynamic that is likely to kick up a storm.

Bullish equity sentiment may persist in the second quarter on the Fed’s pause, but tight monetary policy, financial instability, elevated recession odds, extreme US polarization and policy uncertainty, and still-high geopolitical risk should encourage investors to maintain a defensive position for the coming 12 months.