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Monthly Macro Newsletter July 2022

For professional investors only The month of June was again another complicated month in global markets as the common protagonists – inflation concerns and growth concerns – dominated sentiment, creating an environment of uncertainty and complexity that led equity markets to their worst H1 since the 1960’s, and bond markets even longer. The ECB led the DM central bank’s further hawkish iteration at the start of June, with an end to its QE programme and a promise of 25bps in July (and maybe 50 in September), only to disappoint EUR positivity with delay, following the hint of Governing Council disagreement regarding a new anti-fragmentation tool to maintain monetary transmission in the face of tighter policy. However, the ECB was quickly overshadowed by a US CPI print, that rose to a 40 year high of 8.6%. This led to an aggressive rally in front end yields and a renewed bid in the USD, as risk sentiment deteriorated. The surprise beat in US inflation led to a hastily pre-signalled 75bp hike from the FOMC in June, driven by more acute fears of a de-anchoring of medium-term inflation expectations. While Powell suggested that the increment was not likely to be ‘common’, the implications for risk assets was clear. However, as the month progressed, the (front loaded) repricing higher of the US yield curve shifted the focus from inflation to growth, and ultimately drove further stabilisation in DM bond markets (led by the US). Elsewhere in DM, a 50bp from the BoC, RBA, SNB and Riksbank left the BoJ (resolutely unchanged) the outlier pledging to maintain persistent easing.

For professional investors only As the month closed, central bank pledges to get demand and supply back into better balance – with no sign of any let up in the underlying energy supply shortfall – drove recession concerns more globally. The USD surged, most notably against the EUR, while EMFX fared better than the historic risk correlations suggested, with some currencies such as CNY, MXN and INR remaining resilient, while others weakening in line with the hostile backdrop for risk.

For professional investors only Geopolitical and macroeconomic headwinds continue to create a hostile backdrop for the global economy, as it rebounds from the Covid crisis. As we look ahead towards July and H2 2022, markets will be continuously assessing whether inflation will continue to drift higher, driven by second and third round effects; and additionally, whether persistent or even peaking inflation are accompanied by an end of the economic recovery – concluding one of the shortest business cycles in recent history. We group our key thoughts on the global economy and markets into three broad themes below.

For professional investors only The first half of 2022 was the worst year for US equities since the 1960’s, as an extraordinary chain of events and chain reactions gave rise to significant uncertainties at the government, central bank, corporate and consumer levels. However, there are a number of reasons to be more positive about the prospects for equities in H2. (i) While markets are increasingly concerned about an impending recession brought about by a tightening of financial conditions in response to inflation – there is still significant strength in labour markets, and in wage growth, consumer and corporate balance sheets remain strong and there are signs of easing in some global supply bottlenecks. (ii) Recent Fed hawkishness has regained control of the inflation narrative from market viewpoint, and many indicators suggest that the is little evidence of de-anchoring of long-term inflation expectations. In combination, this likely indicates a Fed cycle which is close to fully priced by the markets – further hawkish shocks are less likely. (iii) Sentiment and positioning towards global equities are negative, despite the fact that US equities have now fallen further than comparable (validated) recessionary periods. (iv) The significant mark-down in equity prices this year has come as a function of pricing, or multiples, while earnings forecasts have remained resilient. Rather than looking at this as a sign earnings will be the next shoe to drop, we remain positive for many of the reasons laid out above. Q2 earnings season begins in early July, and will remain an important test, but could also be an important reference point for very extended negative expectations.

For professional investors only Despite the pessimism in the market regarding the dollar during the past two years, related to the US CA deficit, the European Recovery Fund, fiscal imprudence in the US and other structural flaws in the US economy, the sharp USD appreciation has been one of the most notable developments in financial markets in H1 2022. We have long argued that the vast size and depth of US financial market, and the key role of the dollar as in global FX transactions for capital account purposes ought to trump other detracting factors, such as CA imbalances. Considering the contractionary monetary policies of the Fed and the bid on safe-haven assets in recent months, investors ought not be surprised by the dollar strength thus far this year. The hostile macroeconomic and geopolitical backdrop faced in Europe is also a crucial consideration in thinking about EURUSD. That said, we think we could be approaching the point of a ‘peak hawkish’ Fed; interest rates may be peaking in the US. This should translate into a modest pullback in the dollar, if the Fed’s actions do not exceed the market’s pricing. There is an important caveat of course, that we have inflation wrong (and we have been too sanguine on inflation); if there is a wage-price spiral, then the Fed might not have other options but to continue to tighten, and the dollar can overshoot significantly, as it did in the early-1980s.

For professional investors only China’s economy has decoupled from that of the West for much of the past 12 months, not only because China has had a different Covid cycle, but it also has had a different policy cycle. Just as the US and Europe are slowing, China is recovering from a policy-induced growth recession in H1. The analysts’ opinions differ on how fast the recovery will be in H2, but our outlook is positive, as China benefits from very low inflation, and will likely not face any shortage of labour or supply chain disruptions as it recovers; thus, aggregate demand and aggregate supply ought to recover in synch with each other. As the economy recovers, large spending on infrastructure projects (supply-side policy, not demand stimulus) will persist. Monetary policies will be targeted (targeted credit measures, but no 2009-11 like opening of the flood gate), in order to support industrial growth without stoking the property bubble again. Importantly, regulatory easing will also assist the process: no more clampdowns or crackdowns on anyone in H2. Thus, while Beijing might not achieve its 5.5% annual growth target, 5.5% for H2 is entirely achievable, in our view. China’s recovering growth momentum ought to be a supporting factor for the global economy, as we look ahead.

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