Insights

Outlook

China's reopening supports our view of a soft landing. The beginning of the year brought respite for some of the risks dominating the global economy. First, the speedy end to lockdowns in China should result in a near-instant uptick in domestic demand, which will benefit all trading partners. Second, easing pressures on Europe's energy markets helps relieve some of the region's challenges. This good news underlines our opinion that the economy is heading for a soft landing.

Higher-than-average inflation continues to diminish consumer purchasing power and the real estate market, as tighter interest rates discourage corporate investment. However, some positives are still in place, such as households still sitting on considerable savings and labor markets remaining healthy.

Inflation will continue to decline, but central banks will remain vigilant. Improving commodity prices, especially for energy, should substantially ease inflation over the next few months for developed economies. However, the consequences of the price shock that hit a year ago will continue to increase, mainly through wages, keeping underlying inflation high. As a result, central banks will likely continue to tighten policy in the short term and stick to their hawkish tone until they are sure that underlying inflation can be brought nearer the target.

Investment strategy remains cautious, with greater regional variations. Accordingly, we retain the broadly cautious tone of our investment strategy and equities underweight. However, risks of an overly unfavorable scenario are receding, leading us to raise exposure to emerging market equities and commodities while continuing to overweight European vs. United States stocks. In addition, we remain overweight on US sovereign bonds and top-rated US corporate debt in this higher-rate environment.

Headwinds are receding, confirming our opinion of a shallow economic slowdown. Energy prices are falling, and China has reopened its economy, two pieces of positive news for the world economy. Nevertheless, high inflation and policy tightening by central banks will continue to hamper developed economies. However, the support factors already at work should help offset these effects and reduce the risk of a deep recession. Headline inflation will fall rapidly, but continued underlying tensions will encourage central banks to maintain tight monetary controls.

Headline inflation should fall back, but underlying inflation will take longer to come down as existing pressures continue to spread through the economy. Central banks will keep hiking rates at the beginning of the year and then take a pause. The rise in interest rates continues to make different categories of bonds look attractive. Central bank tightening now seems to have been mainly priced into the bond markets, which are paying good yields, including in real terms. As a result, we are overweight in the top-rated corporate debt and US sovereign bonds. In Europe, however, we could see further adjustments to long-term yields and remain neutral. China's reopening is good for emerging market equities, but the economic slowdown has prompted us to stay globally cautious in our allocation. However, the reduction in specific adverse risks leads us to continue slightly increasing our position in equity markets, including emerging markets.

United States. US stock market indices have performed well since the new year on the back of globally receding inflation. Markets now appear to have priced in the coming drop-off in inflation rates and the end of the Federal Reserve's monetary tightening phase. However, the market still looks costly based on long-term trends, especially so during a time of favorable real rates. What is more, results season, which has shown mixed results so far, indicates that corporate earnings growth could be decelerating. Given this setting, we maintain a practical assessment of the US equity market.

The UK. In 2022, the United Kingdom's FTSE 100 beat the MSCI World thanks mainly to its sizeable energy and commodities shares. Now, the Chinese reopening is set to benefit the UK market. However, this reliance on broad commodities also comes with risks, mainly if a more substantial slowdown in the US economy should translate into falling energy prices. However, downside risks should be controlled as the broader index's valuations remain solid.

Eurozone. The European market has recently performed well, beating other developed equity markets due to expectations of a speedier easing of inflation. Eurozone equities have benefited more directly from catastrophic developments in the energy sector failing to materialize and the reopening of China, which is likely to benefit many European businesses. As a result, revenue forecasts should be revised upwards, but the ECB's resolve to keep monetary conditions tight will likely slow any upside for European stocks in the near term.

Japan. We remain underweight in Japanese equities. China's reopening should be good for Japan, but the emergence of inflationary pressures undermines the Bank of Japan's monetary policy intentions, leading us to take a cautious stance.

Equities. With the drop in headline inflation in some developed economies and China's reopening, confidence has returned to the equity markets since the start of the year. That said, the prospects for the global economy are unclear as the United States economy continues to falter.

Emerging markets. The unexpectedly quick reopening of China should cause a jump in growth, notably as people rush to spend the substantial savings estimated to have accumulated during the lockdowns. This rebound in the Chinese economy would be good news for other economies and many exporters in emerging economies.

Fixed income. We are Neutral on developed sovereign debt in a situation of easing inflation and growth. Credit yields have steadied at an appealing level; however, we are cautious of the repercussions of the continuing economic slowdown.