Our outlook for Q2 2022 argues that we are witnessing nothing less than the arrival of the end game for the paradigm that has shaped markets since the advent of the Greenspan put in the wake of the LTCM crisis of 1998. The twin shocks of the pandemic and Russia’s invasion of Ukraine have shifted priorities on all policy fronts, including fiscal, monetary and geopolitical. In the US, the imperative for the Fed to grapple with spiralling inflation risks has disrupted the traditional rinse and repeat of bailing out financial markets and the economy at the first ripple of trouble. Shortly put, the strike price of the “Powell put” is far lower than it was a year ago—the Fed must get ahead of the curve. In Europe, the Russian invasion of Ukraine has seen Germany tossing decades of fiscal and defence policy out the window, ushering in a new era of investment that should drive a strong rise in productivity. EU existential risks have disappeared as defence priorities soar above all other considerations. Helmets on, as 2022 will prove a wild ride for global markets.
Our macro outlook picks apart the argument that we are seeing a repeat of the 1970s as the world faces a supply shock unlike any it has previously seen. It’s one that risks a “great erosion” as negative real rates erode purchasing power on all levels and rising costs erode profit margins for corporations. Productivity must eventually improve to address this, but the prospects for productivity gains from the green transition are questionable.
In fixed income, the outlook focus is on the rapid flattening of the US treasury yield curve as an inversion threatens and points to rising recession risks. We also look at rising yields across Europe on a less accommodative ECB and, given the new fiscal expansion, what this could mean for EU peripheral spreads. In the credit space, central bank tightening will continue to turn the screws on credit spreads, possibly risking a tantrum at some point.
In equities, our focus is on equity valuations under siege from supply-side constraints, rising input costs and the prospect of far higher interest rates. Winners from here will be companies that can boast strong innovation, pricing power and profitability. In Europe, companies that absorb the enormous new fiscal push in defence, energy and other industries will likely benefit. We also present a special feature piece on cybersecurity, an industry that was already booming before Russia’s invasion super-charged focus on cybersecurity vulnerabilities on all levels—government and corporate.
In commodities, the focus is on the continued upside risk for oil that was already in place before the Russian invasion of Ukraine badly aggravated forward supply uncertainty. We also look into a supportive backdrop for industrial metals on the priorities of new military spending, the metal-intensive green transition and—as Russian supplies are disrupted—on sanctions. Elsewhere, rising food prices remain a risk as a corollary of rising energy prices, but also if this year’s Ukrainian wheat crop can’t get to market, as it is a major exporter. The gold story remains bullish as an inflation hedge and as long as real rates remain negative.
In currencies, the focus is on the potential comeback for the euro on the massive shift in fiscal outlays that has been triggered by the Russian invasion of Ukraine. This will keep more of EU savings in the EU and deepen capital markets there. We also break down how spiralling inflation and the sanctions against Russia’s central bank have likely accelerated the move away from USD primacy as the global reserve asset of choice.
Finally, this outlook features a rundown of the technical outlook for important assets from gold and crude oil to US equities, and in particular the remarkable multi-decade perspective on the Dow Jones Industrials.