BNP AM

The sustainable investor for a changing world

Several factors explain the recent renewed appetite for risky assets and the fall in government bond yields. Investors appear increasingly convinced that the tightening cycle by central banks is nearing its end and that Beijing is seeking to relax its zero-Covid strategy.  

In recent months, investors’ assumption of a ‘pivot’ in monetary policies fuelled an upturn in risky assets, with global equities rising by 14% over October and November. However, we believe the tightening cycle has further to go. Employment data remains surprisingly robust. This is particularly the case in the US although the Federal Reserve (Fed) has raised rates at the fastest clip.

The latest US jobs report surprised to the upside with strong hiring (263 000 net job creations in November) and a further acceleration in wage increases to 5.8% year-on-year for production and non-supervisory employees.

This pace is definitely too high for a lasting return of inflation to the Fed’s 2.0% target. In October, the central bank’s preferred inflation measure (the private consumption expenditures excluding food and energy deflator – core PCE) stood at 5.0%.

With a monthly average of 392 000 net new job creations since the beginning of the year, the US labour market remains remarkably strong. 

Recent market moves gives us the impression that investors are somewhat perplexed and have been adjusting their positioning after November’s sharp volatility. In just one week, global equities lost 3.0% (MSCI AC World index in US dollars) and emerging market equities fell by 2.0%, despite Chinese equities continuing to rise (+1.3% for MSCI China in USD).

The 10-year US Treasury note yield fell by around 10bp to 3.40%, reaching its lowest level in nearly three months. The EUR/USD exchange rate stabilised above 1.05, its highest since the end of June.

Recession in 2023: Inevitable?

The sell-side consensus forecast is for a recession in the US and the eurozone over the next 12 months. According to business surveys, the downturn in global economy deepened in November: The global composite purchasing managers’ index fell to 48 (from 49 in October) to the lowest level since June 2020.

The only encouraging news from these surveys was the decline in inflationary pressures on inputs. A gloomy take on this would be that it reflects falling global demand. Consumer price indices have also come off the boil. It appears that the peak in inflation may have passed, but that consumer prices will remain high in absolute terms – too high for central banks’ price stability targets.

Many ways to pivot  

The pace of policy rate increases looks set to slow and central bank rhetoric should become less hawkish in the coming weeks. The Fed has already said that the rate rise expected to be announced on 14 December would likely be only 50bp (after four consecutive 75bp increases).

At his press conference on 14 December, Fed Chair Jerome Powell is due to present the central bank’s latest projections for GDP growth, inflation and employment. He will also indicate the level of policy rates deemed ‘appropriate’ by Federal Open Market Committee (FOMC) members.

We already know that the target level for the federal funds rate forecasts will be higher than that presented in September. Powell may wish to comment on the easing of financial conditions during the intervening period, and how it may be counteracting the objectives of the current tightening cycle.

The Governing Council of the European Central Bank (ECB) meets on 15 December. Market expectations of the size of the next key rate rise have fluctuated given that inflation stood at 10% year-on-year in November. That is five times the ECB’s target rate.

However, the latest comments – including from the governors of the central banks of France and Ireland – have supported calls for a 50bp rate rise and the idea that the subsequent trajectory of policy rates will be agreed on a meeting-by-meeting basis.

The officials have also stressed that a restrictive monetary policy is necessary i.e., policy rates should exceed 2.00%. It is expected that the deposit rate will be raised to that level on 15 December.

The Bank of Canada’s Governing Council, which met on 6 December, raised its key policy rate by 50bp to 4.25%. The consensus had been for a 25bp move. The BoC foresees further tightening, saying that ‘looking ahead, the Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target’.

Consequences for portfolios

Investors are adjusting their positions ahead of 2023, which is likely to be a year of moderate recession – even if equity indices and earnings estimates have yet to reflect that – and slow disinflation (which is perhaps already overly priced in by markets). We struggle to see any strong conviction behind the latest market moves Is it a relief rally? A ‘Santa rally’? Short-covering?

The extent of the recent fall in long-term bond yields in particular raises questions given that monetary tightening is likely to continue in the coming months.

However, we do not think this justifies avoiding equities. We still favour the Chinese and US markets over eurozone equities, leaving us with a neutral equity exposure overall.

In the bond markets, investment-grade (IG) euro-denominated bonds look attractive, so we are maintaining our exposure. Commodities are providing diversification in our portfolios.

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related insights

Investment symposium – Macroeconomic themes for 2023
Graph of the week – Monetary policy - ECB has further to go than the Federal Reserve
BNPPAM

Investments in the aforementioned fund are subject to market fluctuation and risks inherent in investing in securities. The value of investments and the revenue they generate can increase or decrease and it is possible that investors will not recover their initial investment. Source: BNP Paribas Asset Management.

UCITS OFFER NO GUARANTEED RETURNS AND PAST PERFORMANCES DO NOT GUARANTEE FUTURE ONES

To access insights from our teams worldwide visit:
BNP AM
Explore VIEWPOINT today