Searching for bright spots in a trickier phase

Recent inflation and growth data from the US indicates continued strength in the economy, leading us and various institutions including the IMF to revise up US growth. We see the current strong momentum to continue into Q2 but expect a deceleration in H2, without negative growth in any quarter. Data on the inflation side also points to stickier prices, with upside risks from the recent geopolitical escalation (oil). This opens a difficult phase for central banks such as the Fed for which we expect fewer rate cuts but higher uncertainty around policy actions. In addition, investors should assess the following factors:

• The dichotomy in US economy. Small business vulnerability to high rates vs large business resilience and the low income households fragility vs the high income strong consumption are key features of this cycle. Higher for longer rates will further increase these vulnerabilities. We still see the Fed cutting rates but at a slower pace, with a small risk of no cuts.
• Europe shows a clearer picture vs US allowing the ECB to start cutting earlier. Here as well we see slower rate cuts and also highlight that divergences in Central Bank actions will require FX to be closely monitored.
• Emerging markets offer bright spots to consider. Asian economies in particular prove overall much more resilient and more autonomous/driven by regional forces. India remains a bright spot and a structural growth story.
• Rising geopolitical risks will affect overall market visibility. With inflation risk in focus, geopolitics is increasingly relevant for oil prices, while demand for gold as a safe-haven diversifier could support the metal.

Markets seem to have priced in much of the good news on resilient growth and slowing inflation, and there are risks to consider. Investors should focus on these bright spots that could provide better risk-return:

• In cross asset, we maintain a slightly constructive view on risk assets but focus on resilient market segments. US duration offers potential but we continue to diversify into Italian BTPs. On Japanese bonds, however, we are cautious. In our view, Euro high quality is the brightest spot in credit. We also like EM debt for carry, but we slightly reduced our stance as sticky EM inflation lowers the potential for further rates compression. In equities, we are positive on Japan and now also on the UK. We did some recalibration in EM towards our long term convictions. While we are positive on India, Indonesia and South Korea, we reduced the stance on Korea slightly but turned positive on Mexico. ?
• With an active duration stance overall, we have reduced our expectations of Fed rate cuts owing to strong US growth and inflation. However, rates volatility would remain high. There is good value in the short to intermediate portion of the US Treasury curve. In Europe, we are neutral on duration, positive on UK but cautious Japan. Selection is important in credit, leading us to maintain our preference for investment grade (IG) over high yield (HY), both in Europe and the US. ?
• In equities, there are signals of rotations within equity markets, that favour global equity approaches. We expect top-of-market earnings to decelerate in the US, supporting a catch-up of the rest of the market which should favour an equal weighted approach. In Europe, we stay balanced and slightly raised the tilt towards defensives through utilities. Overall, we are positive on industrials and consumer staples and cautious on tech and consumer discretionary (slightly less though). ?
• We are positive on EM, but recognise that sentiment in bonds is less supportive due to a delayed Fed pivot/fewer rate cuts). However, yields remain attractive and so is economic growth. In hard currency, we prefer HY over IG due to better valuations and carry. The EM universe offers plenty of opportunities even in equities. We choose to be more selective in favour of Brazil, Mexico, Indonesia, India and Korea (slightly less than before). But geopolitical risks present a major overhang. ?

More on: https://research-center.amundi.com/article/global-investment-views-may-2024