Last Week in a Nutshell
- In an intense disruption of commodity markets amid the invasion of Ukraine by Russia, oil prices have skyrocketed. Russia also happens to be one of the world’s significant producers of crude oil.
- Households are feeling the pressure of rising inflation as the US CPI came out at 7.9% YoY in February. Following the war in Ukraine, expectations are for even higher levels next month.
- The EUR recovered, boosted by improved risk appetite, a more hawkish than expected ECB and reports that EU leaders were considering joint bond issuance to finance climate, defence and energy spending.
- Diplomatic efforts between the Russian Foreign Minister, Sergei Lavrov, and his Ukrainian counterpart, Dmytro Kuleba, have not proven fruitful despite their meeting held in Turkey.
What's Next?
- The Fed is expected to increase its funds rate by 25bp for the first time since December 2018. The vicious circle of disruptions in supply chains and rising commodity prices is still on-going and the war adds substantial upside risk to inflation.
- Central banks will be in the spotlight as the BoE and the BoJ along with their emerging markets counterparts will all hold meetings.
- Key countries will release their first hints at the impact of inflationary pressures and the war in Ukraine via Economic Sentiment figures for the euro area and Germany and regional manufacturing sector surveys for the USA.
- On the geopolitical front, more sanctions on Russia might be announced as Western allies are eager to discourage Russia from lingering. NATO defence ministers will also hold a meeting.
Investment Convictions
Core scenario
- The Russian military invasion of Ukraine is leading to significant tensions and altering the market outlook over the medium term. For now, a scenario of above-potential economic growth remains achievable but numbers’ range may be lower in the short term.
- The latest messages sent by the Fed (interest rate lift off and balance sheet run off) and the steepness of the path towards monetary tightening will also condition performance in 2022. On a medium term, liquidity reduction is a turning point.
- In the US, elevated inflation and rather strong growth, while expected to fade in 2022, should drive interest rates and bond yields higher.
- In Europe, the ECB announced it will stop buying bonds this summer. The announcement paves the way for an increase in interest rates, possibly later this year.
Risks
- The Russia-Ukraine war is pushing energy prices further and continue weighing on investor sentiment while sanctions usually end up hurting both sanctioned and sanctioning parties.
- A supply shock due to the global geopolitical tensions may weigh on activity and corporate earnings growth.
- By the same token but specifically in the US, if the tensions abate, a brutal, faster-than-anticipated rate tightening - if inflationary pressures increase and/or persist - could jeopardize the recovery.
- The COVID-19 and its variants underline the risk of a stop-and-go in economic restrictions.
Recent actions in the asset allocation strategy
The war in Ukraine has added new uncertainties for investors. The most immediate economic impact is an upward revision in inflation forecasts for this year to 5% and a downward revision in GDP growth forecasts to 3.4% for the euro zone in our central scenario estimates. As a consequence, uncertainties, already on the rise due to the expected monetary policy tightening in the United States, have risen further. The invasion of Ukraine and the subsequent economic sanctions on Russia have caused us to be prudent in our allocations. The longer the conflict lasts, the more vulnerable the world economy becomes through a negative feedback loop. This has led us to position our portfolios in a broadly balanced way. Our Multi Asset strategy must cope with the new uncertainties and remain nimble. We know from the past that armed conflicts do not have a lasting impact on markets, except when they lead to an energy crisis.
Cross asset strategy
- Our most recent strategy adjustments to the increasing volatility include derivatives strategies to protect our exposure to equities. We have an overall neutral positioning on equities with a focus on:
- defensive sectors and quality stocks among healthcare, materials, energy and climate segments,
- assets set to benefit from the sizeable joint EU bond issuance for energy and defence spending.
- via China (rebound of credit impulse) and
- via Latin America (support from rising commodity prices)
- The current inflation backdrop explains why our allocation to fixed income continues to focus on:
- a short duration,
- a diversification among inflation-linked bonds and source the carry via emerging debt.
- In our long-term thematics and trends allocation: Our convictions spread across Health Care, Demographic Evolution and Consumption, Climate Change and Innovation. In the current context, we privilege the former, but setbacks on the latter thematics could provide attractive entry points.
- In our currency strategy, we have exposure to CHF, JPY and USD, which play their safe haven role.
