Retreating Inflation: What Now?

In recent weeks, the risk landscape has shifted from concerns over rising inflation to growing fears of a somehow more tangible softness of the economic cycle. While inflation appears to be converging towards Central Banks’ targets, weakening macroeconomic indicators are raising concerns that restrictive monetary policies could dampen growth more severely than anticipated.

In this context, Central Banks are signaling that a softer monetary stance is needed to support growth. At the September meeting, the ECB met market expectations with a 25-basis points rate cut, while the FED began its rate-cutting cycle more aggressively with a 50-basis point cut. The bond and stock market response reflect little surprise,? and the FED’s move could influence a previously unexpected Eurozone rate cut in October. Despite the recent 30 basis point rate cut by China’s central bank, monetary policies are still seen as insufficient to counter deflationary pressures and economic weakness, limiting the full recovery in oil demand and contributing to lower commodity prices. However, the latest fiscal stimulus announced by the Chinese government could help stabilize the property market and boost consumption, which in turn may lift economic growth.

?As the US election approaches, the race between Harris and Trump remains highly competitive, fueling some uncertainty that might become more visible as we get closer to the election day and, potentially, even through it.

In this uncertain environment, a cautious yet constructive approach is preferable. Rates markets already incorporate an important easing cycle, with 6 and 8 rates cuts respectively priced in Eurozone and US for the next 12 months.

While this leaves investors exposed to possible short-term disappointment, still the benign inflation profile and a softening economic cycle should support in the medium run both government bonds, particularly the intermediate maturities, and investment grade credit in both Europe and the U.S.

For equities, the near-term outlook appears more challenging, particularly in Europe, as China’s slowdown has hit key sectors like luxury goods and autos. However, these sectors could see an improvement in their fundamentals if the Chinese monetary and fiscal policies will prove to be effective. In contrast, US equities, that are supported by a stronger economic environment, usually enjoy a positive price action in the weeks after a presidential election as the political uncertainty is solved.

Despite short-term uncertainties, selective opportunities exist for investors willing to navigate this volatility. A balanced, flexible strategy focused on quality assets will be key to successfully managing this environment.