Against the backdrop of the energy crisis in Europe, rising interest rates in developed markets, strengthening US dollar and the UK nose diving into a gilt market, Fidelity International has outlined three key themes to watch for the remainder of the year.
The first is whether there would be a soft, hard or crash landing. This is as hopes that the US Federal Reserve (Fed) would soon pivot away from its tightening path have been squashed, says Fidelity International head of macro and strategic asset allocation Salman Ahmed
“In two consecutive meetings, the Fed hiked rates by 75 basis points and it has struck a consistently hawkish tone since Jackson Hole at the end of August. The central bank appears fully committed to getting inflation under control, even at the cost of significant demand destruction,” he adds.
Nevertheless, economic data in the US is proving relatively resilient. The labour market is still healthy and inflation remains high, points Salman. Fidelity International’s future activity trackers improved in August while the US dollar continues to strengthen. On the back of these, the firm has pushed out its expectations for a hard landing in the US to mid-2023.
Recession in Europe, meanwhile, appears more imminent. The region faces a severe energy crisis that Fidelity International estimates could lead to a 4%-5% hit to euro area GDP.
“High prices and threat of gas storage depletion are sapping consumer spending and hobbling the industry. The European Central Bank (ECB) has hiked rates to 0.75%, but the window for further tightening is closing quickly given the deteriorating outlook,” says Salman.
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The second theme to watch is China’s 20th Party Congress. While Europe and the US wrestle with recession, Chinese policy is heading in a very different direction, says Salman. “China is continuing to loosen policy where most developed markets tighten and it has room to go further still,” he adds.
Nevertheless, several challenges remain this winter and the economic recovery following zero-Covid policy lockdowns has been mixed, Fidelity International finds. While activity has improved, recurring lockdowns and a property sector in transition have left a dent in China’s economy. In response, China has ramped up both fiscal and monetary support, which should improve its outlook towards Q4 this year.
Fidelity International expects Chinese earnings to improve as companies begin to enjoy a post-Covid recovery and lower commodity prices. “We believe sentiment could improve further following October’s 20th Party Congress and we are closely watching for clues of how the forward path of economic policy could serve as a catalyst for a more progressive growth policy. Expectations heading into the Congress remain muted, meaning any positive news could provide an immediate boost to sentiment,” says Salman.
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The last theme involves monetisation to fiscalisation. Salman highlights that Europe is facing a bleak winter — many things now depend on how governments try to support households and businesses over a winter of severely elevated gas prices.
The risk of fiscal largesse in an environment of high inflation and rates has been underscored by the UK, where recent radical policy changes triggered a collapse in sterling and a sharp rise in gilt yields necessitating Bank of England interventions. On the other hand, the ECB is trying to normalise monetary policy, despite the near certainty of recession across Europe.
“At the same time, there are reasons not to be too pessimistic. Governments are likely to increase their fiscal support for households, many of which still have a pot of lockdown-induced savings to draw upon.
“Confidence across the region might be at rock bottom but retail sales are holding up for now and unemployment remains low, though deterioration in hard data looks to be in the pipeline. We don’t know yet how cold this winter will be, along with the knock-on implications on gas demand, nor how the current phase of global financial conditions tightening will impact future policy settings and specific regions pose their own questions,” says Salman.
Staying defensive
In an environment where attractive investment options appear scarce, pockets of opportunity and higher hopes for 2023 could be found in Asia. Fidelity International portfolio manager, multi asset Taosha Wang says Asia will be on a different path this winter in a number of ways.
For one, the region’s key economies serve as a useful diversifier that is insulated to a degree from the struggles facing Europe, with less inflationary headwinds. This implies more headroom for growth-oriented policies in the region, which differs from many other parts of the world where high inflation is forcing central banks to tighten financial conditions.
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“Additionally, the 20th Party Congress in China could herald more policy certainty heading into 2023 and increased assertiveness in government stimulus. China has already eased various property policies in response to a soft housing market. That said, overhangs from zero-Covid policy in China, foreign exchange volatility due to dollar strength and uncertainties related to the Bank of Japan’s yield curve control regime still warrant some caution,” says Wang.
Fidelity International is turning more positive on Asia and remaining defensive overall. With a tighter monetary policy required to combat inflation, the firm expects further weakness in risk assets. “With growth slowing and real yields surging, we are conservatively positioned with an overweight to cash.
“Within equities, we prefer US equities to Europe, as Europe faces a uniquely negative economic outlook driven by energy prices. Nonetheless, we continue to identify thematic investment opportunities that can withstand the fluctuation in economic cycles. Renewables is an interesting example where we are seeing a long-term sustainable growth theme intersect with near-term demand from the ongoing inflation energy crisis,” adds Wang.
