Below, the key highlights from the asset allocations report by Denis Panel, Head of MAQS and Daniel Morris, Chief Market Strategist at BNP Paribas Asset Management, are outlined.
“We believe confidence in the growth outlook could wane in the short term, particularly given the recent weakness in China, ‘stagflation risk’, and an earnings reporting season dominated by ‘margins squeeze’ concerns. Looking further out, we continue to favour equities over government bonds as growth strengthens, inflation pressures wane, and central bank support falls away only slowly.” Denis Panel , Head of MAQS.
Key highlights include:
Europe macro – A positive outlook, but vulnerable
Europe is more vulnerable to the disruptions from the post-lockdown reopening than the US. The increase in natural gas prices is more damaging as it is a much more important energy source for the region, and manufacturing is a larger part of the economy, particularly in Germany.
However, the outlook is still positive. Consumer confidence has held up despite lingering worries about Covid and higher prices. So far, the surge in energy prices has not derailed spending. Supply and energy issues should abate, the EU support funds will be disbursed, labour market dynamics remain favourable, excess savings are high, and eased travel rules should boost tourism.
For the first time in a long time, core inflation is now around the ECB’s target. Our calculation of the seasonally adjusted monthly changes in core inflation components shows cooling pressures, however. We expect core inflation to fall to below the 2% target by the end of next year. Upside risks include minimum wage hikes, offset by easing supply chain stress.
US macro – Headwinds
It has become clear that supply chain bottlenecks and inflation will last longer than thought. We expect core inflation (as measured by the Personal Consumption Expenditure index) to rise for another year, to around 4.4%, before falling back to 2% in 2023.
To deal with the higher prices, households will likely draw down some of the savings they accumulated during the pandemic.
The US Federal Reserve can be expected to increase its projections of future interest rates – in the ‘dot plot’ – in December and will be preparing the market so that this does not come as a surprise.
China macro – Beijing to the rescue?
China has been facing numerous challenges recently: debt-laden property developers, Covid infection outbreaks, flooding, and now power shortages. However, government efforts to boost supply and damp demand have led coal prices to drop sharply. They could fall further in the coming weeks as increased imports add to coal and gas supplies.
As Chinese growth slows, many observers expect renewed measures from the government to spur a rebound by increasing credit. The credit impulse has often led economic growth in China by around six months.
Markets and central banks
Our medium-term outlook is upbeat: solid growth, modest inflation pressure and loose monetary policy. In the short term, we worry that confidence in the growth outlook will wane, particularly given the weakness in China. Stagflation is one of the key concerns for investors.
Since markets have now assimilated the news on inflation, and concerns over property developers in China have waned, earnings are the key focus. Despite worries over margin pressures, reported results have been surprisingly strong. While supply and labour shortages have weighed on CEOs’ minds, the ability of many companies to pass along price increases has helped maintain margins.
Meanwhile, 10-year US Treasury yields have risen further, driven almost entirely by inflation expectations alongside higher US core inflation. The market increasingly sees inflation higher for longer as Covid disruptions linger, energy prices surge and rental inflation is teed up to accelerate in US.
Market expectations of what central banks will deliver have changed. The US Federal Reserve is now expected to raise interest rates more frequently – twice by the end of 2022. Expectations for ECB policy are also shifting in a market that is increasingly sceptical of its ‘temporary’ inflation narrative.
We expect the ECB to try to push back against this view by stressing that it expects rates to remain at present or lower levels until at least the end of 2022. It will be important that it emphasises that rate rises are unlikely in 2022 and 2023. If not, markets may assume that rates will still go higher later.