Investors are underestimating the sturdiness of economic fundamentals, that predict higher nominal GDP growth in this cycle, says Evan Brown, global chief strategist at UBS Asset Management in his latest Macro Monthly. “Being an optimist about the durability of the global expansion currently is a more attractive risk-reward proposition.”
Short-term interest rate markets are sending a clear message: the beginning of global monetary policy tightening is at hand. The average expected policy rate in one years’ time for eight developed market central banks doubled over the past month to roughly one percent, a level above pre-pandemic pricing, says Brown.
“In some cases, this surge is contrary to central bank guidance. Investors are leaning into the idea that the stickiness of well above-target inflation will prompt monetary policymakers to act to prevent expectations from becoming unhinged to the upside. In our view, the more important question for asset allocation right now is not when central banks will tighten policy, but by how much.” According to Brown, despite the sharp rise in expectations for near-term tightening, the market-implied ‘terminal rate,’ or peak fed funds rate this cycle, is still 50 bps below the peak rate last cycle. “Essentially, markets are arguing that with a few hikes, central banks will swiftly quell inflationary pressures and we will return to a world of slow growth and slow inflation. Indeed, long-term inflation-adjusted US yields are near record lows. This combination suggests investors are concerned about the magnitude and persistence of short-term inflationary pressures, but pessimistic about the medium-term growth outlook.”
Brown retains a more positive outlook. “Investors are underestimating the sturdiness of economic fundamentals, which portend higher nominal GDP growth in this cycle. Household and corporate balance sheets began the expansion in a position of strength, fiscal drag is not poised to be as fierce of a headwind this cycle, and widespread shortages are boosting incentives for businesses to invest in capex. Indeed, the causes of elevated inflation today are the sources of robust growth in the tomorrows to come. Of course, either view – ours or the market’s – could ultimately prove correct. But based on what is being discounted, we believe that being an optimist about the durability of the global expansion is a more attractive risk-reward proposition.”