Cross Asset Investment Strategy - October 2022

Geopolitical risks, inflation and hawkish central banks translate into a cautious stance on risk assets such as credit, in which, a deceleration in growth (and its impact on earnings) could create concerns over cash flows and liquidity, especially for the lower rated companies. Hence, we prefer US IG and are defensive on HY. On the other hand, USTs are attractive at current levels, but investors should stay active and also explore select opportunities in euro area curves. In equities, we favour US over Europe and selectively like quality, value names that can sustain earnings and reward shareholders even in a downturn.

The US Congress’s August approval of the Inflation Reduction Act (IRA) came as a surprise to most observers. With the mid-term elections just months away and no majority in Congress, no one expected new legislation to be passed. Yet, the Democrats and Republicans managed to reach a compromise. We discuss below the measures announced to promote the environmental transition, which is the centrepiece of the act. Europe has much to gain from looking more closely at the modalities of the new US green industrial policy..

The first electoral round was won by former President Lula. However, the incumbent, Bolsonaro, performed better than expected. Their economic agendas differ on a number of issues, while risks are more asymmetric under each candidate. Either could benefit from a robust macroeconomic scenario.

TLTRO repayments and redemptions will drive incoming ECB passive QT over the next few quarters. So far, banks have repaid a small amount of liquidity, while the ECB’s recent decision on remuneration of excess reserves has helped keep current excess liquidity abundant, aiming at a smooth transmission of its monetary policy.

The flattening of the US yield curve will depend on the persistence of core inflation and on the impact of monetary tightening on growth. The more resilient the US economy proves to interest-rate hikes, the more aggressively the Fed will have to tighten monetary policy, thereby increasing the risk of recession. We have gone from ‘bad news is good news’ to ‘good news is bad news’.

We keep the same probabilities for the three families of risks. We see risks growing on all fronts, closely linked to each other. Economic fundamentals are deteriorating globally (which is reflected in the central scenario). The course of the war in Ukraine and its potential implications can tip the scenario in either direction. We consider Covid-related risks (including lockdowns in China) as part of the economic risks. Risks are clustered to ease the detection of hedging strategies, but they are obviously related.

Macroeconomic Picture by area and Macro and Market forecast.