With the massive economic dislocation created by the Covid pandemic, the U.S. Federal Reserve Board (Fed) has been very cautious so far not to jeopardize the recovery by tightening too soon. Things have changed rapidly in the last few months. The labour market is running hot and inflation hasn’t been so high in 40 years. As a result, the Fed has changed its message and is now making clear it’s concerned about inflation and will act to prevent expectations from de-anchoring.
Asset Class highlights
Equity: Investors who expect a repeat of the double-digit gains experienced over the last 2 years will likely be disappointed. We are more likely to see flat or slightly positive returns. The risks and headwinds facing equity investors are coming from different directions, and the probability of the downside risk is increasing.
Fixed Income: In the first quarter, increasingly hawkish guidance by the Fed and the European Central Bank (ECB) led market participants to re-price higher their policy rate expectations in a significant way. Going forward, we believe these re-pricings have planted the seeds for future Developed Market bonds’ positive performance. In terms of Emerging Market Bonds’ allocation, we remain cautious (as in the last quarter).
Currencies: With elevated debt levels, we believe there is limited space for rising U.S. real-yields from current levels, limiting U.S. dollar(USD) strength. Excessive valuation, along with deteriorating fundamentals, such as a large current account deficit and political uncertainty ahead of mid-term elections, could lead to renewed weakness. Given the offsetting forces at work, we expect the USD to stay in consolidation mode over the forecast horizon—that is, within a relatively wide trading range.
China: We have been well below consensus in recent quarters, mostly because of housing. Recent developments have surprised us on the downside. Among them, new home sales have remained weak. Weak consumer fundamentals and Omicron are additional headwinds.
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