SUMMARY
If the US Federal Reserve is successful in reducing inflation while not causing a recession, we expect low single-digit gains for global equities and bonds through the end of 2022.
- Financial markets got a bit of a reprieve this past week as investors took some comfort in comments from the Federal Reserve’s May meeting minutes.
- Inflation is still a problem for the economy and will likely continue to be for the rest of the year. But signs that demand will slow while supply recovers give us comfort that the Fed has a path to a lower inflation rate without requiring a truly hard landing. But signs that demand will slow while supply recovers give us comfort that the Fed has a path to a lower inflation rate without requiring a truly hard landing.
- We expect low single-digit gains for global equities and bonds through the end of 2022 of the Fed is successful in controlling inflation without triggering a recession. However, if the Fed is unsuccessful and constrains growth too quickly or reduces liquidity too severely, a recessionary scenario can unfold with more severe consequences for equities.
- While our base case is that the expansion will endure, we see the risk of US recession as higher than usual in 2023 (35%) – a material risk.
- This leads us to one of our key calls, which focuses on high quality fixed income. We think there are compelling opportunities to bring high-quality bonds back into portfolios.
- In our view, most of the expected US tightening is now embedded in Treasury yields. We believe that rates will peak this year, as US GDP growth decelerates rapidly. In turn, this will likely see a slow reduction in inflation readings, perhaps allowing the Fed to relax its hawkish stance by late 2022.
- For investors, these higher yields may represent an attractive level at which to buy. We believe certain fixed income assets now offer an “antidote” to the “cash thief,” given their higher yields.
