Monthly House View - March 2022 - Download here
Inflation continues to surprise to the upside. This trend is perhaps not all that surprising given the spike in energy prices, and it is not hard to make the connection between inflation, rising oil and gas prices, and geopolitical tensions. This could once again drive the temporary inflation narrative, namely that it is caused by energy and will decline quickly.
Looking at the latest US inflation figures, we believe this is a risky misconception for several reasons. First, because these figures show that the rise in prices is distributed across the vast majority of components. Second, because one might expect a mechanism where wages react to inflation and vice versa. This would bring us closer to a sustained inflation scenario, or at least one that lasts longer than expected. With more moderate wage growth in Europe, we are still a long way off, but the old continent’s low level of unemployment could lead to an acceleration in the coming quarters. So we need to be cautious about the dynamic nature of this process and monitor the chain reactions at play.
This inflationary phenomenon could have an impact on growth. The middle classes’ actual purchasing power challenges the theory of the COVID-19 savings glut. Low-income households are bearing the brunt of higher fuel prices, which leads to higher wage demand and changes in consumer choices. This is what is currently missing from the relatively consensual and optimistic scenario for global growth, which assumes GDP is not to be affected at this stage by inflation and rate hikes.
This concern has likely been factored into the central bank equations and they might not move forward with all the rate hikes the market is currently expecting.
The Fed and the European Central Bank (ECB) diverge in many areas, due to both the differences in their economic environments and the specific nature of their missions. But what they seem to have in common is the desire to not trigger a recession or sharp downturn in the markets through massive normalisation, especially if growth were to show signs of weakness.
Monetary policy is, however, anything but neutral for the markets, yet a paradox remains. While there is some recognition that actions by the central banks helped financial asset prices recover strongly starting in the spring of 2020, it is less commonly agreed that monetary policy leads to an adjustment in the equity markets and corporate bond spreads, even if that is exactly what has happened since January.
Some signs of weakness due to inflationary pressure are also starting to emerge at company levels. Until now, they had continued to beat growth and profitability records, responding to higher costs with higher prices to shore up their margins.
Fourth-quarter results were a high point, but business leaders are cautious about the trend for 2022, while margins are falling for industrial stocks.
We therefore need to be humble and pragmatic as we start the year in the face of an ever-shifting reality, in which trends are not as well established, and a higher-risk regime.
March will be packed with challenges and should provide some answers regarding the strategy adopted vis-à-vis the central banks. If the economy holds, the Fed will start its announced rate hikes. Conversely, if the international environment, market volatility or economic trend worsen, then it will be time to check whether the Greenspan put1 still exists.
1- The idea is that the Fed becomes accommodative again when financial conditions worsen (an expression that was coined after the 1987 crash when Alan Greenspan came to the markets’ rescue).
Monthly House View, 18/02/2022 release - Excerpt of the Editorial
February 24, 2022