House Views - September 2022 - Central banks and "whatever it takes" to tame inflation

Even in the best case, inflation will take some time to fall back. Events over the summer seem to confirm inflation has peaked in the United States, but price pressures will only subside fairly gradually. In Europe, fresh jumps in energy and food costs continue to power inflation and raise doubts about whether it is likely to decline short term. All of which encouraged central bankers, gathered at the Jackson Hole symposium in the United States, to reaffirm the priority of the fight against inflation, ‘whatever it takes’ in terms of economic impact.
 
This latest trailed tightening of monetary policy poses an additional risk of recession for developed economies. True, a number of support factors are still in play – buoyant labour markets and plentiful savings – but activity should nonetheless slow sharply in coming quarters. In the United States, even without considering monetary policy, high inflation and restrictive budgetary policy are already damping demand. In the euro area, household purchasing power is being particularly hard hit because of the feeble growth in salaries. New pressures on gas and electricity prices raise a real risk that some industries will have to cut production triggering a sharp recession. In further bad news for the global economy, China’s outlook is also weakening, as the government sticks to its zero-Covid policy and the real estate market struggles.
 
Greater prudence in our investment strategy. We have redoubled our prudent approach to equity markets, reweighting towards defensive and resilient sectors. We retain our Underweight to the euro zone in light of the specific risks overhanging the region. At the same time, we are Neutral on bond markets, having done well from our Underweight early in the year. Yields may now look tempting, particularly real yields, but another rate hike would knock performance back again. We are also exiting our euro/dollar Underweight as the cross has already fallen substantially. Finally, we are reducing exposure to Hedge Funds, which are looking less appealing as interest rates rise.

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