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Navigating a European (and Global) Stall Speed Economy
Central bankers in Europe are walking a tightrope amid inflation and potential recession, as the global economy slows while key components of inflation persist. Chief Investment Strategist for EMEA and APAC Wouter Sturkenboom, CFA, explains how investors can keep their balance with modest risk-taking.
Economic growth has slowed across the developed world approaching stall speed. This environment challenges investors and policymakers in the UK and eurozone because growth has not weakened enough to bring inflation down quickly, but it has weakened sufficiently to elevate the risk of recession. Central banks will likely find a middle ground by winding down rate hikes. Thereby, providing support for modest risk-taking through high-yield bonds and commodity-related equities. Let's take a closer look.
A large decline in energy prices and plentiful government aid has allowed the UK and eurozone to skirt a recession to date. But now, their economies have stalled, leading indicators have flat-lined, and credit growth has started to decline. The consumer is feeling the pinch from a decline in real income and higher interest rates have hurt the housing sector and business investment. Expectations for corporate earnings growth have been trending down. We expect growth to disappoint modestly relative to expectations with the risk of recession gradually rising towards the end of the year.
With growth stalling and energy and goods inflation rolling over, the European Central Bank and Bank of England have shifted focus to stubborn services and food inflation. So we still see signs of hawkishness by central banks, but they are walking a tightrope between increasing rates enough to contain inflation and too much to trigger a recession. This task is further complicated by the hard to measure impact of the unrest in the banking sector.
In the end, we think both central banks will take forward-looking, data-dependent views that include risks to future credit growth. We expect the data to push them in the right direction, which we believe, in turn, lowers the risk of over tightening. Our base case calls for one or two 25 basis point rate hikes in the upcoming meetings.
A stall speed economy poses a challenge to investors. As earnings growth declines, the risk of recession rises and inflation takes longer to come down. We believe central banks will pay heed to the increased uncertainty by moving gradually. We think this limits the potential for over-tightening, which supports a modest overweight to risk. We choose to take risk through high-yield bonds and natural resource equities while under-weighting duration along with US and emerging market equities.