Skip navigation Scroll to top
Scroll to top

LGT Private Banking Europe House View – August 2022

July 27, 2022

Major central banks are tightening their interest rates screw and the economic outlook gets increasingly gloomy. The time has come to upgrade our cross-asset rating for the fixed income space to “neutral”. We downgrade inflation protected bonds down to “unattractive”, and upgrade government bonds and duration to “neutral”.

LGT Private Banking Europe House View

The European Central Bank (ECB) has joined the club of interest rate raising central banks last week and surprised the markets on the hawkish side with a 50 basis points raise and a clear communication. Likewise, the Federal Reserve (Fed) is expected to tighten the interest rate screw by another 75 basis points at the next meeting (27th of July). Of course, the tighter monetary policy of the major central banks has consequences for global economic growth. Not only are estimates for 2022 and 2023 increasingly gloomy, but also the growth outlook differs from region to region. The probability of recession has steadily increased over the past few weeks. We see the following three scenarios for the coming months:

Main scenario (70% probability)

Price pressure peaks during the summer months, first in the US and with a time lag also in Europe. On an absolute basis, inflation starts to moderate, but declines more slowly than in the past. The Fed and the ECB will continue their rate hike cycle along current market expectations, but there will be no tighte-ning of monetary policy. Economic growth continues to weaken and in the major economies we are getting close to or even into a moderate recession in the short-term.

In this scenario, the tightening of monetary policy screws combined with inflationary pressures will lead to declining demand for economic goods. Supply chain bottlenecks are expected to ease materially and Russia will continue to supply gas to Europe, albeit less than desired by key customers. Although inflationary pressures are starting to ease, central banks have too little flexibility to keep economic growth at potential. 

Pessimistic scenario (20% probability)

Inflation remains stubbornly high and monetary policy is tightened further. Growth expectations are gloomy. The consequence would be a “hard landing” and thus a deep recession. A prerequisite for this scenario would be an increasing escalation of the energy supply crisis with gas as well as electricity, which would have its epicenter in Europe. However, these effects would then spill over to the global economy. A possible energy rationing in Europe in winter would hit the industry and the consumers hard. A possible stagflation scenario coupled with a deep recession in Europe would then be almost unavoidable.

Optimistic scenario (10% probability)

The supply chain problems resolve much faster and consumer demand remains more robust than expected. Similarly, Russia supplies sufficient gas and there is thus a de-escalation in Europe before the winter months. The consequence would be a faster normalization of inflation rates and more room for maneuver for central banks, which could then display more benevolent rhetoric. This would lead to a classic “soft landing”.

Macroeconomic outlook

In our main scenario, we expect a further decline in economic momentum in the coming weeks and months. Due to inflation expectations both in the US but also in Europe, the market expects a further acceleration of price pressures. Much depends on the tense energy situation in Europe, which has definitely mutated into a pawn between Russia and the West. One bright spot, however, is the consumer in the US, which is surprisingly robust despite record low consumer satisfaction (see page 4). Growth in China is already lower than potential output and the government in Beijing is trying to support the economy with stimulus measures.

Investment strategy

For quarters, fixed income has had an unattractive view across assets. With the economic downturn now expected and interest rates rising in recent months, the time has come to upgrade the rating to “neutral”. Thus, we are positioning ourselves a notch more defensively across assets. The equity market has already priced in most of the economic downturn, but not yet a recession. The equity risk premium is at best in the historical average and therefore, in our view, the time has not yet come to build up risk. We maintain our view that selection is a key success factor in the current highly complex environment, also in Q3 2022.

Equity strategy

We maintain our regional preference for the US over Europe. While European indices are at a more favorable valuation level than those in the US, the “energy” risk for the Eurozone conti-nues to justify an “unattractive” rating. The US is further advanced in the monetary policy cycle and therefore, despite a higher P/E valuation, US equities (“attractive” rating) are to be preferred to European securities. We also prefer companies with defensive qualities and pricing power on a global basis.

Fixed income strategy

As described above, we are increasing our fixed income rating from “unattractive” to “neutral”. However, the opportunities remain modest, especially for a euro and Swiss franc investor. We see the greatest potential in US government bonds. We also increase the duration to “neutral” and reduce TIPS (inflation-linked bonds) to “unattractive”. We continue to see the greatest potential in the subordinated segment and maintain our “attractive” rating.

 

 

LGT helps you make informed investment decisions

All about global economic and market trends at a glance

Subscribe to LGT's research newsletters

You can also follow us on Facebook or LinkedIn – or visit MAG/NET and discover interesting background articles. If you have questions, a consultant from the bank will be happy to help you.

Imprint
Publisher: LGT Bank (Switzerland) Ltd., Glärnischstrasse 36, CH-8027 Zurich
Author: Thomas Wille, Chief Investment Officer, Email: thomas.wille@lgt.com
Editor: Alessandro Fezzi, E-Mail: alessandro.fezzi@lgt.com
Source: LGT Bank (Switzerland) Ltd.

Risk Disclosure (Disclaimer)
This publication is an advertising material / marketing communication. This publication is intended only for your information purposes. It is not intended as an offer, solicitation of an offer, or public advertisement or recommendation to buy or sell any investment or other specific product. The publication addresses solely the recipient and may not be multiplied or published to third parties in electronic or any other form. The content of this publication has been developed by the staff of LGT and is based on sources of information we consider to be reliable. However, we cannot provide any confirmation or guarantee as to its correctness, completeness and up-to-date nature. The circumstances and principles to which the information contained in this publication relates may change at any time. Once published information is therefore not to be interpreted in a manner implying that since its publication no changes have taken place or that the information is still up to date. The information in this publication does not constitute an aid for decision-making in relation to financial, legal, tax or other matters of consultation, nor should any investment decisions or other decisions be made solely on the basis of this information. Advice from a qualified expert is recommended. Investors should be aware of the fact that the value of investments can decrease as well as increase. Therefore, a positive performance in the past is no reliable indicator of a positive performance in the future. The risk of exchange rate and foreign currency losses due to an unfavorable exchange rate development for the investor cannot be excluded. There is a risk that investors will not receive back the full amount they originally invested. Forecasts are not a reliable indicator of future performance. In the case of simulations the figures refer to simulated past performance and that past performance is not a reliable indicator of future performance.

The commissions and costs charged on the issue and redemption of units are charged individually to the investor and are therefore not reflected in the performance shown. We disclaim, without limitation, all liability for any losses or damages of any kind, whether direct, indirect or consequential nature that may be incurred through the use of this publication. This publication is not intended for persons subject to a legislation that prohibits its distribution or makes its distribution contingent upon an approval. Persons in whose possession this publication comes, as well as potential investors, must inform themselves in their home country, country of residence or country of domicile about the legal requirements and any tax consequences, foreign currency restrictions or controls and other aspects relevant to the decision to tender, acquire, hold, exchange, redeem or otherwise act in respect of such investments, obtain appropriate advice and comply with any restrictions. In line with internal guidelines, persons responsible for compiling this publication are free to buy, hold and sell the securities referred to in this publication. For any financial instruments mentioned, we will be happy to provide you with additional documents at any time and free of charge, such as a key information document pursuant to Art. 58 et seq. of the Financial Services Act, a prospectus pursuant to Art. 35 et seq. of the Financial Services Act or an equivalent foreign product information sheet, e.g. a basic information sheet pursuant to Regulation EU 1286/2014 for packaged investment products for retail investors and insurance investment products (PRIIPS KID).