Inflation/Deflation
In this week’s report, we speculate on the evolution of euro trading in light of the near-term hiccups, but tremendous value that can be unlocked for longer-term investors.
Rather than teetering into recession, global growth has firmed since the start of the year. While we still expect inflation to decline, the risk that central banks will need to lift rates more than discounted has increased. Long-term focused investors should start raising cash allocations by trimming their equity holdings.
The rebound in growth is pushing up inflation. More aggressive monetary policy is likely to trigger recession over the next 12 months or so. Investors should stay defensive.
Bulls and bears are perplexed because they suffer from recency bias. The investment roadmap and framework of the past 15 to 20 years should not be used to analyze current US financial markets. US corporate earnings will likely plunge substantially even in the case of a mild recession.
Investors should avoid / stay underweight Turkish stocks and local currency bonds versus their respective EM benchmarks. Stay underweight Turkish sovereign credit.
In this Special Report, BCA’s Foreign Exchange Strategy and Global Fixed Income Strategy teams argue that as the lagged impact of higher interest rates hits the Canadian economy, what will initially appear as a potential hard landing will morph into a mild slowdown. During the process, Canadian government bonds will outperform, and the CAD will drop, setting the stage for a coiled-spring rebound.
In Section I, we address the recent improvement in several data releases over the past three months, and explain why we do not believe that these developments have increased the odds of a soft landing. US monetary policy likely became tight in November, which has started the recessionary clock. We continue to recommend a conservative investment stance over the coming 6-12 months that anticipates eventually lower long-maturity bond yields. In Section II, we explain why the Fed’s unreasonably low neutral rate forecast is the main risk to a conservative investment stance over the coming year, as it could lead to interest rates falling back into easy territory before a recession begins. For now, this remains a possible but not probable outcome.
This week’s report considers the risk that inflation will be stickier than we anticipate, and looks at what a fair value for the 10-year Treasury yield might be in a scenario where the Fed keeps the policy rate on hold for a prolonged period.
Long-term drivers, including the growing ability of banks to returns cash to shareholders, point toward a strong structural performance for European financials. However, the ECB’s aggressive tightening campaign could still spoil the party.