The inflationary crisis that we face is changing the very structure of financial equilibriums that we have known for about 20 years. This increase in prices has several causes : Covid crisis, supply chains disruptions, war in Ukraine, lack of fossil fuels investments, etc. with repercussions on all financial assets.
As a direct consequence, central bankers all have (or almost all) drastically changed their tone in recent months :
- United States : the Fed increased its key rate by 150 basis points. They have signaled their will to continue their restrictive monetary policy to arrive at a key rate of around 3-3.5%, while reducing its balance sheet
- Europe : the ECB abandons its asset purchase program and announced its first rate hikes in July.
- Switzerland : the national bank has started to raise its rates and will possibly be joined shortly by the Japanese central bank who is not satisfied with the hurtful depreciation of the yen.
This global monetary policy tightening logically leads to less accommodating financial conditions with real rates rising sharply in recent months (see real 10-year Euro and US rates opposite).
Since 2008 we have lived with an inflationary risk close to zero and very accommodating central banks. This has allowed real rates to fall and favorised financial assets’ high valorisations (real estate, credit, shares, etc..). This trend is now behind us, and this should remain the case if inflation continues to be the main problem for central bankers.
Soaring inflation, skyrocketing energy prices for the consumer and increasingly restrictive credit conditions all have a negative impact on growth across all sectors and more specifically on the consumer. Consumption levels remain strong in most developed economies, led by the United States, thanks to the savings accumulated following the various support plans. It is very likely however that it will gradually decrease in the coming months. Although the inflation’s source is mainly linked to supply issues, central bankers want demand to crumble in order to curb inflationary pressures.
This is especially true in Europe, with demand already showing tangible signs of a strong slowdown. Having no means of acting on supply, central banks will therefore try to achieve a difficult objective: slowing the economy without causing a recession; a historically difficult balance to achieve.
In light of all this, we believe that growth forecasts will continue to decline over the medium term, which should lead to lower earnings estimates for companies. These companies will find it difficult to counter more expensive financing, margins pressure and reduced consumption, whose price elasticity should increase. The decline in risky assets now reflects the tightening of financial conditions but are not pricing earnings’ drop yet. In our opinion, it seems too early to turn positive on bonds or equities, despite already pronounced declines. Diminishing inflationary pressures appears to us to be the main condition for the financial markets to stabilize. It is currently extremely difficult to get an informed opinion given the determinants of this inflation.
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