What are the current financial mega-trends to be aware of?

In this column, my objective is to take you around the world to discuss the business, economic and financial mega-trends which are top-of-mind for executives, investors, and policymakers.

USA

On the red-hot topic of inflation, high profile investors are criticizing the Federal Reserve for failing to control rising prices. And critics are right to throw their toys out of the pram. Inflation has soared. But the Fed finds itself between a rock and a hard place. On the one hand, if they tighten too quickly by raising rates and unwinding bond purchases, they risk slowing economic growth and potentially sending the economy into a recession. On the other hand, if they remain dovish for too long, they risk price surges leading to demand destruction and financial instability which might be even more dangerous.

No one likes the two-handed economist. So, what’s the best hand to play? Over the coming months, the Fed will most likely continue to tighten but at a much slower pace than previously expected due largely to the increased uncertainty presented by the tragic events in Ukraine. Slow, steady, and well-telegraphed monetary action will hopefully help moderate some of the inflationary pressure. But it would be wishful thinking to believe the Fed will take the punchbowl away too quickly and risk a major policy mistake.

Has the Treasury Department reacted? Janet Yellen, US Treasury Secretary and former Chair of the Fed, has refused to offer an inflation forecast for the end of the year but has stated that she does not expect a recession in the US. What’s her rationale? She thinks the US benefits from both a strong economy and a resilient labour market. She is right on both counts. Other reasons to remain positive include a strong housing market (house prices up 18.5% year-on-year in 2021 with the average size of new loans hitting a record) and easy access to credit. Let’s hope the optimists are correct!

How have the investors and analysts reacted? Goldman Sachs has lowered its target for the S&P 500 index for a second time this year, implying less confidence in US equities. What’s their thinking? Higher commodity prices translate into less consumer demand and weaker economic growth. That doesn’t feel very bullish…

Europe

As if the inflation backdrop was not uncertain enough, it could get murkier. What are two factors which might contribute to further price increases? Russia cutting natural gas supplies to Europe via the Nord Stream 1 pipeline and its continued assault on Ukraine leading to slashed harvests, and less food stock. We were hoping for a COVID recovery. We are getting anything but – as global trade begins to decline and investors get defensive.

Speaking of defense, spending on armament is about to go through the roof as Germany announces intentions to boost expenditure ASAP, with France to follow. President Putin may have intended to weaken NATO, but it appears that he is achieving the exact opposite.

Finally, the ECB is hinting it may change course over the coming months to stop net bond purchases in Q3 and potentially raise rates in Q4. The Euro has been weak of late and we have profited from this in our GBP portfolios. But will this end soon? That’s a big debate for our investment committee but I suspect we will moderate our negative position on the Euro in the near-term and take profits.

UK

Our economy bounced back quickly at the beginning of the year, but it feels like old news as the ‘soaring costs of living’ dominates headlines. That said, consumer spending did strengthen in February (13.7 % higher than pre-pandemic levels) as offices reopened and social life resumed.

But this all changed with the Russian invasion of Ukraine. A big question now facing investors and policy makers is around energy security and whether net-zero is going to take a back-seat to military expenditure. Can we achieve both? Do we have the budget?

Prime Minister Boris Johnson is developing plans for a new energy supply strategy to counter the high energy prices. The new plan could include more oil and gas production but one thing for sure is that we can all expect more nuclear generators at a power-plant near you soon.

Asia

The first big question on investors’ minds as it relates to Asia is whether the commodity shock will derail the Japanese economy. Our response is probably not, but there has been an impact indeed as Japan registered its biggest current account deficit since the start of 2014 – not encouraging!  But the Bank of Japan appears adamant on remaining accommodative (unlike their peer group) and the office of the PM Fumio Kishida seems determined to supply fiscal support. Perhaps Japan will be able to weather this volatility?

On China, the big question remains – can the property market recover? The real estate market represents a significant percentage of GDP which has been slowing. Will the recent headwinds in the property market serve as a drag on economic momentum? China’s new strap line is ‘homes are for living, not for speculation’. This should tell us something.

However, the recent sell-off in Asian high yield debt and more specifically in the price of bonds linked to Chinese developers may indicate there is significant value on the table. The property sector is undergoing a major transformation as the government forces debt-ridden developers to cut leverage and increase liquidity through wide-ranging regulations.

We are not alone in looking at this sector. Many professional investors are lining-up and readying themselves for when the Chinese central bank starts easing more aggressively. We mustn’t forget what happens when monetary authorities begin to add stimulus… Bonds usually do well. A mirage in the Gobi Desert or a golden opportunity for the taking? Now that’s a question worth considering…