At the start of the year we expected growth to be above the long-term potential in the world’s three most important economies – the US, Europe and China – and we still do. However, we have of course reduced our growth expectations significantly as a result of the war in Ukraine, especially for Europe. We have also increased our expectations for inflation.
Nevertheless, the war is unlikely to send the US or Europe into recession, and Omicron will not put China on the ropes. Given that we see the war remaining a conflict between Russia and Ukraine as the most likely outcome, we currently expect that the US, Europe and China will continue to grow at a decent pace.
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The time ahead – macroeconomy
EUROPE: Still expect solid growth
The impact of the war is most marked in Europe due to its closer connections to Russia, especially in terms of energy supplies. Nevertheless, we are still expecting solid growth over the year as a whole and – if we are proved correct – at above the economy’s long-term potential. This means the economy will continue to absorb the spare capacity remaining after the Covid-19 recession, which it is currently doing rather quickly. Hence, unemployment fell to 6.8% in February, the lowest in the history of the euro area, and the labour market appears to have continued to improve in March.
We see valuations and the economic outlook as being most attractive for equities in emerging markets. Bo Bejstrup Christensen, Chief Portfolio Manager, Head of Macro & TAA.
US: Incredibly strong job creation
In the US, the reopening after Omicon is in full swing again. This is most obvious in the labour market, where job creation has been incredibly strong and unemployment has continued to fall, with weekly jobless claims hitting a 50-year low in March. The strong economy is putting upward pressure on inflation. Given current interest rate levels and the size of the balance sheet, the Federal Reserve is stimulating final demand at a point when it does not need stimulation – to put it mildly. The goal of the Federal Reserve is therefore to get monetary policy back to neutral as quickly as possible and probably also a little tight to cool strong demand and therefore also the labour market. Fortunately, the economy is not fundamentally imbalanced via excessive investment in, for example, construction and/or private consumption, which is why the economy can, in our view, cope with the speedy normalisation of monetary policy.
CHINA: We believe China can contain Omicron
China’s solid start to 2022 is overshadowed by the Omicron outbreak. In the very near term that means lockdowns and restrictions that have already significantly reduced growth. The big question is whether China can contain Omicron without the need for further and potentially far more extensive restrictions than those already implemented – we believe China can. However, the most important factor in our view is that the relatively strong data of recent months confirms the Chinese economy is basically doing well, and that the primary reason for the weak growth last year was the continuous and at times significant tightening of economic policy. Precisely because China has now achieved its goal of getting the economy and the housing market to shift down a gear, the authorities can better stimulate the economy if and when there is a need.
The time ahead – the financial markets
EQUITIES: Will recoup their losses – and more
The war is a human and social catastrophe, but as markets get used to it, the war will have negative but manageable effects from an economic and financial perspective. If we are proved correct in our expectation of continued solid global economic growth led by the US and China, equities will recoup their losses – and more. Despite major regional and sectoral differences, the war will not result in a global recession. That means further earnings growth and a macroeconomic environment where risk premiums on equities can be maintained at current levels.
BONDS: Difference between US and Europe
Following the latest increases in US interest rates, major changes to monetary policy have already been priced in – in the short term, actually a little more than we currently expect. We therefore foresee only modest upward pressure on US interest rates going forward. We thus expect 10-year US Treasury yields to increase by 0.1 to 0.2 percentage points over the coming 12 months, which should be consistent with zero to modestly positive returns on US Treasuries in the coming 12 months.
Things look different in the euro area. Following the latest developments in inflation, we have seriously upped our expectations for rate hikes from the ECB. We now expect the ECB to raise its benchmark rate by 175 to 200bps going forward to the end of 2023 from the current -0.5% to around or just below 1.5%. This is more than the market is currently pricing in. At the same time, we view term premia across the German yield curve as too low, i.e. bonds are expensive. In contrast to the US, we therefore have significant negative return expectations across the entire German yield curve.
EMERGING MARKETS: Most attractive for equities
We see valuations and the economic outlook as being most attractive for equities in emerging markets. Our expectations for monetary policy and yields would normally constitute a challenge for emerging market equities. However, in contrast to the US and Europe, we now view emerging market equities as moderately undervalued. Hence, these markets have a little support from valuations, while valuations are a slight headwind in the US and Europe. Moreover, if our expectations for the Chinese economy pan out, including a significant acceleration in growth as we head for the summer, emerging market equities should be able to deliver decent positive returns in the coming quarters and for the year as a whole.
This publication has been prepared as marketing communication and does not constitute investment advice. Note that historical return and forecasts on future developments are not a reliable indicator of future return, which may be negative. Always consult with professional advisors on legal, tax, financial and other matters that may be relevant to assessing the suitability and appropriateness of an investment.