Cross Asset Investment Strategy - December 2022

We believe the Fed would keep rates in restrictive territory in the near term. This, coupled with concerns over earnings, allows us to stay cautious on risk assets but with select opportunities in US equities, businesses with strong balance sheets, and quality, value and dividend oriented stocks. In credit, some US IG and EM debt appear attractive. However, investors should include protection in portfolios in the form of USTs on which we are more positive now. This approach should be complemented with an overall well-diversified stance that includes commodities.

After several months of informal negotiations, the European Commission proposed on 9 November a reform of the Stability and Growth Pact (SGP) to be debated. Only the broad outlines of the reform have been presented. The Commission has deliberately left the most politically sensitive details open. The reform of the fiscal rules must thus be adopted next year.

The economic backdrop foreseen for the next 12 months suggests that the ongoing correction will continue through the first half of 2023, featuring a profits recession and still elevated (albeit moderating) inflation. In H2 some of the headwinds should abate (with lower price pressures and the Fed on hold), supporting a gradual shift from the current defensive stance (with its tilt towards gold, investment grade credit and, marginally, government bonds) to increased risk exposure (mainly via DM equity and high-quality credit).

Beyond the impact of domestic economic variables, euro rates are determined by the energy crisis and political monetary choices. The combination of a new regime of higher energy prices and persistent expansionary fiscal policy could lead to a debt supply shock and persistent inflationary pressures.

The war in Ukraine will continue to dictate Europe’s prospects in 2023. It will shape local and EU politics, energy security, industrial policy, and international relations. In this article, we outline our expectations for the next phase of the war and offer an optimistic prospect for peace negotiations to lead to a cessation of hostilities in the second half of the year.

The latest support measures the Chinese governments announced on housing have sought to re-establish lifelines for struggling developers, clarifying that credit forbearance would not be considered as stepping on the red lines. After sharp deleveraging over a year, stabilising the market is now the priority.

Lula netted a goal in Egypt at COP27 in the fight against climate change. However, it was an own-goal on the spending front that unsettled the markets and threw doubt on expectations of a prudently populist policy direction. We still believe Lula’s policies will be of a centre-left nature, with the help of the markets, though risks have risen.

We maintain the probabilities of our scenarios unchanged. Some of the risk factors we identify may occur in our central scenario, which is probably not yet fully priced-in by markets. Risks remain skewed to the downside in the short term, but it would take a combination of several risk factors to trigger the downside scenario at the 12-18 month horizon. At this horizon, we believe that the downside is counterbalanced by an upside scenario, that of a rapid decline in inflation due to an easing of gas prices, a ceasefire in Ukraine, and/or to the combined tightening of global monetary policies, the impact of which can be underestimated.

Macroeconomic Picture by area and Macro and Market forecast.