Europe’s outlook this winter remains murky, with Russia escalating its aggression in Ukraine as well as on energy policy. And Chinese policy support is proving an insufficient salve for what ails the global economy, says Evan Brown, Head of Multi Asset Strategy Investment Solutions.
These issues and their ultimate outcomes are still highly relevant. But in light of recent events and price action, an additional three questions have emerged and warrant urgent attention from asset allocators, he says in his latest Marco Monthly.
Does bond market intervention in the UK have broader implications?
Yes, says Brown. “Global policymakers are increasingly wary of the financial stability effects of the sharp rise in yields. The risks to government bonds are becoming more balanced. In China, Japan, the European Union, South Korea, and India (among others), the central bank or fiscal authorities are intervening in foreign exchange or bond markets (or have prepared tools to do so). Central banks are prepared to push back against price action judged to be excessive or counterproductive to their goals.”
Can the US dollar continue to run higher?
Again yes, says Brown. “History shows that the US dollar is expensive on a valuation basis, but also that this condition does not prevent major overshoots. Federal Reserve policy will continue to buoy the US dollar, in our view, as tightening will likely continue without a pivot to easing until material evidence of labour market weakness emerges or inflation returns much closer to target. Neither of those outcomes is probable in the near term. Central bank tightening will cause a series of dominos to fall across the global economy, and the US labour market is likely to be the last to topple. Globally, the goods sector will come under more stress, and has ample room for continued retrenchment as the share of spending continues to rotate towards services. The US is in a relatively better position to withstand headwinds because a lower share of GDP is linked to goods, Europe is more exposed to the energy price shock, other housing markets are more sensitive to interest rate movements (the 30-year fixed rate mortgage is the dominant US product) and China has been unwilling to durably reopen economic activity.”
What is the outlook for earnings?
Brown expects earnings to be increasingly negative. “Over the past two years, at least one of growth or inflation has been either accelerating or surprising to the upside, giving an extra boost to revenues and profits. Going forward, it is quite likely that neither growth nor inflation will do so. Downbeat sentiment and relatively low expectations increase the potential for squeezes to the upside in risk assets during earnings season so long as results are not as bad as feared. But over time, the macro conditions will dominate. Falling purchasing managers’ indexes, the strong dollar, and waning commodity price imply profit estimates have further to fall from here. We believe that unless there is a fiscal or geopolitical policy change that provides strong cause to believe that revisions will soon turn, this downward pressure will remain a headwind for risk assets.”
Here you will find the complete Macro Monthly from UBS Asset Management.