For weeks, capital markets have been under the spell of the Ukraine conflict, which finally completely escalated last week. As a consequence, the West has tightened sanctions against Russia step by step. Over the weekend, the G7 nations have decided to exclude Russian banks from the global transaction system Swift, which is essential for financial institutions to operate globally. This in turn increases the risk that Russia will react with countermeasures that are likely to affect Europe’s energy safety in particular. This could not only cloud consumer confidence, at least in the short-term, but also continue to increase inflationary pressure and slow economic growth. Geopolitical risks are likely to remain enormous in the coming weeks, confronting capital markets with great uncertainty and volatility.
In stress situations, financial markets usually react with a rapid increase in volatility and a flight to safe-haven assets such as government bonds, gold and the US dollar. This effect can be observed also this time, but in a weakened form. Thus, we have seen rotations mainly within asset classes, with US equities, for example, being among the winners within the equity quota. In our view, however, what is important now is whether investors adjust their expectations with regard to monetary policy and expect fewer interest rate hikes due to the geopolitical crisis. The focus here is primarily on the Federal Reserve (Fed). But despite the conflict over Ukraine, financial markets are betting on a rapid Fed rate hike cycle and continue to forecast five to six interest rate hikes of 25 basis points each for 2022.
In the current situation, much remains unclear and specific economic effects are difficult to quantify. Nevertheless, the macro-economic picture is still constructive in our view. The normalization process in terms of economic growth, monetary policy and fiscal policy support is ongoing. However, It is not proceeding smoothly, because in addition to the sustained problems in supply chains due to the pandemic, geopolitical tensions are now adding to the burden. As a result, there is a risk that inflationary pressure will not ease as early as anticipated in spring, but will remain high until the summer or even fall. This could put pressure on the major central banks to raise interest rates quickly at the short end, which would harm economic growth.
Our macroeconomic outlook remains constructive, as global economic growth should continue to be clearly above potential this year. The leading indicators (PMIs) support this positive assessment. The biggest threat now is clearly the war in Ukraine and the conflict with Russia, which could negatively impact global macroeconomic momentum as well as raise inflation expectations. However, in our view the focus remains on the Fed, which is likely to start an interest rate hike cycle in mid-March.
At asset allocation level, we remain defensively positioned with an overweight in liquidity, a neutral position in equities and commodities, and an underweight in bonds. In the current environment, calm and patience are called for. It is not the time to take big risks, but to stick to the long-term strategy. The positioning of investors tends to be risk-off and sentiment indicators are correspondingly negative. With further potential market weaknesses in the coming weeks, these contra indicators could turn positive. The focus is on selection in all asset classes.
In mid-February we reduced the global banking sector, specifically European banks, to “neutral” and thus removed risks from our portfolio. Within the equity allocation, we favor sectors that benefit from the rise in commodity prices and maintain our cautious positioning in the technology sector in the short-term. We expect a friendlier environment for global equities in the second half of this year, when the Fed's rate hike cycle has begun, and geopolitical uncertainties have subsided.
It appears that currently the bond market is more important to the Fed than the Ukraine conflict. In the past two weeks, we have not seen a flight to US Treasuries, nor has the number of expected Fed rate hikes for 2022 and 2023 decreased. Due to the current high inflation rate, we expect continued upward pressure on long-term interest rates and therefore maintain a short duration in our portfolios. Also in turbulent times, we remain overweight in hybrid bonds and in AT1 bonds in particular. However, in our view, the key to success is selection. Therefore, careful due diligence of individual issuers is necessary to be able to generate positive returns at all. In addition, gold belongs in every private client portfolio and we are increasing our gold allocation from “neutral” to “overweight”. Gold’s defensive properties as a safe haven as well as the long-term overvalued US dollar speak for an exposure to the precious metal in the medium to long-term.
Publisher: LGT Bank (Switzerland) Ltd., Glärnischstrasse 36, CH-8027 Zurich
Author: Thomas Wille, Head Research & Strategy, Email: firstname.lastname@example.org
Editor: Alessandro Fezzi, E-Mail: email@example.com
Source: LGT Bank (Switzerland) Ltd.
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