Economy
Economic activity has slowed amid rising costs and supply disruptions following Russia’s invasion of Ukraine. Economists have generally lowered global growth expectations since the beginning of the year, especially for Europe, where the war’s impact is high. Despite strong consumption and business spending, imports and inventory have dragged down growth. Nevertheless, global economic growth continues, although recent data have been mixed. In the U.S., the Fed has sharply pivoted in a hawkish direction to combat surging inflation. While the odds of a U.S. recession are still subdued for the near term, recession risks rise substantially as we look out to 2023. Fallout from the war in Ukraine could push the eurozone economy into recession, given rising energy costs and disrupted supply chains. Emerging markets (EM) growth expectations have been revised lower given the war’s impact and a slowdown in China.
Inflation
Interest Rates
Investment Outlook
Economy
Inflation
Global inflation remains elevated despite the consensus view that the worst may be behind us. While goods prices show signs of moderating, service sector inflation continues a steady rise. Developed market inflation also remains high due to the spike in oil and food costs. High and persistent inflation, the longer it remains, risk becoming embedded in inflation expectations, fueling demand for wage increases, and becoming a self-fulfilling prophecy.
Interest Rates
The Fed and other major central banks are focused on tightening monetary policy to tame inflation, which surged beyond their earlier expectations. The ECB confirmed that it would conclude net asset purchases by July 1 and start its rate hike cycle at its July meeting. The Bank of Japan remains an exception, making no changes to its current policy stance and framework yet. Central banks in EM continue to raise rates, as most are facing inflation above their target range.
Investment Outlook
While a multitude of risks remain, equity markets are already pricing in a high risk of recession with many markets experiencing drawdowns of more than 20%. While stocks could fall further on concerns over the Russia-Ukraine war, persistent inflation, and COVID lockdowns in China, the Chicago Board Options Exchange Volatility Index is already at historically elevated levels. Given improved stock market valuations and low odds of an imminent U.S. recession, stocks could experience a powerful relief rally from here.
While we are resisting becoming increasingly bearish on stocks in the context of market declines, we are still pursuing a fairly cautious investment strategy. We are neutral on stocks in our multi-asset portfolios, while overweighting commodities and cash and underweighting fixed income. The outlook for fixed income returns looking forward has improved significantly on notably higher yields on 10-year U.S. Treasury notes and wider spreads on fixed income risk assets. We are considering increased exposure here.