- U.S. economic data is sending mixed signals. The labour market remains robust with intense wage pressures. Meanwhile, housing activity is in correction mode because of rising interest rates while business surveys are softening fast. We expect the pace of economic growth in Canada to slow into yearend. The North American economy is cooling, not crashing.
- Because of our concerns about the three-to-twelve-month economic outlook, our portfolios remain tilted defensively and we remain underweight to both equities and fixed income, alongside a small underweight to duration, leaving our asset mix overweight of cash.
- Across regional equity markets, we are overweight of Canadian equities and remain neutral on U.S. and Emerging Market (EM) equities but underweight to Europe, Australasia, and the Far East (EAFE), which we think remains the most vulnerable to the ongoing macro backdrop as the energy crisis worsens in Europe. We downgraded high-yield credit in favour of investment grade credit.
- On a sector basis within the U.S equity market, we remain overweight to the energy, healthcare, and tech. We have a currency hedge against the U.S. Dollar. Our fixed-income heavy portfolios are underweight credit exposure to reflect our more defensive views of the markets.
The Inflation Slayer: The Fed will “Keep at it”
U.S. Federal Reserve (the “Fed”) Chair Jerome Powell delivered a powerful market-steering speech in Jackson Hole, Wyoming (Source: CNN) where he insisted on the Fed being dedicated to slay inflation with high interest rates. While his speech was short, it was unambiguously clear and even alluded to what investors have believed for a while, that the battle against inflation would bring “some pain” for the economy: “reducing inflation is likely to require a sustained period of below-trend growth”.
Back in July, investors began entertaining the idea that the Fed was about to “pivot” away from its hawkish rhetoric and switch to a dovish policy stance. Because this market narrative largely fueled the equity rally into early August, the risk-off market reaction was severe as Powell delivered a wake-up call to the markets. Bonds yields and the U.S. Dollar rose while equities suffered heavy selling for the reminder of August. The European Central Bank and the Bank of England also joined the hawkish campaign with rate hikes in recent weeks, which sent global bonds into an historical rout, down over 20% from their January 2021 peak (Chart 1). Although we think fixed-income market probably underestimate the degree of tightening the Fed and other major central banks will have to deliver to slay inflation, we are nevertheless approaching the later innings of the hiking cycle, which means that 10-year yields have less upside when sitting above 3%. Overall, we think the risks remain titled for higher long-term yields, until the economy hits a major speed bump that sparks a wave of layoffs.
Chart 1: Global Monetary Policy Tightening Causing Epic Bond Rout
Meanwhile, U.S. economic indicators have maintained their mixed tone as the labour market remains robust. Unsurprisingly, in the eye of the rate-hike storm lies the housing market, which is starting to correct as home-sales have tumbled in recent months.
Global Markets in August: Equities and bonds feeling Powell’s pain
Chart 2: The Unstoppable Greenback
Europe Outlook: Increasing risks for a winter chill
Europe’s supplies of natural gas are increasingly jeopardized as Russia weaponizes energy and turns to economic war in retaliation against economic sanctions (Source: Reuters). While European countries agreed to a 15% gas savings plan (Source: SP Global) and they seek to protect their industries from energy-supply disruptions, we nevertheless expect economic activity to be negatively impacted beyond the upcoming winter unless a peace deal is reached over Ukraine, but this optimistic scenario appears unlikely at this point. To help households and businesses avoid paying stratospheric spot energy prices (Chart 3), European countries are rolling out extraordinary subsidies (Source: Bloomberg). While subsidies will partially shield energy consumers from shocking energy bills, the true economic cost is likely to be measured in excess of $1tn, which will add to the inflationary dynamics and require governments to increase their projected deficits and bond issuance.
Chart 3: Soaring Natural-Gas Prices More Painful for Germany Than The U.S
Oil Outlook: What happens when the U.S. is done draining Strategic Petroleum Reserves?
Chart 4: Are Oil Inventories Set to Fall Once SPR Releases Expire?
Outlook and Positioning: Pulling out safety measures as markets remain turbulent
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