Policy

Stocks will only get temporary relief from gridlock. Inflation will abate but then remain sticky. US and global policy uncertainty and geopolitical risk will remain historically high.

Stocks will only get temporary relief from gridlock. Inflation will abate but then remain sticky. US and global policy uncertainty and geopolitical risk will remain historically high.

A client concerned about the slump in asset prices, the stubbornness of inflation, and rising bond yields asks what went wrong, and what happens next? This report is the full transcript of our conversation.

Central banker messaging after the latest rate hike announcements in the US, UK and Australia indicates a shift in focus from the pace of hikes to how high rates must rise to slow growth and bring down inflation. This represents the next stage of the global tightening cycle, where rates will go higher in countries where neutral rates are higher, like the US, compared to countries with lower neutral rates like the UK and Australia.

Financial markets slumped with the tough talk that followed last week’s FOMC meeting, but investors should recognize that the tone of the Fed’s communications is conditioned upon the inflation backdrop. Once it improves, Chair Powell and his colleagues will be able to relax their rhetoric.

In this report, we identify 5 key signposts that will mark a turn in the dollar. These include technical conditions, foreign real interest rates, US (and global) yield curves, Chinese economic conditions and geopolitics. We then assess whether it is time to short the dollar.

Provided that US inflation is due to excess demand rather than supply constraints, demand destruction will likely be needed to bring core inflation below 3.5%. Such growth contraction is positive for counter-cyclical currencies like the US dollar. In China, the Party's focus is to alleviate structural inequality and a long-term confrontation with the US; and authorities are not yet panicking about the cyclical state of the economy. Hence, an economic recovery is unlikely in the coming months.

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.