29-Jun-22 Macro

Target adjustments

Putin's gas and more aggressive central banks require corrections...

  • Most central banks have now prioritized fighting inflation; the Fed is willing to risk a recession.
  • In Europe Russian natural gas supply is at risk.
  • These two factors are the main drivers of our revised forecasts.
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War changes the inflation picture...

War has brought unwelcome and rapid change to the international picture and our macroeconomic and, above all, inflation forecasts must change, too. Uncertainty about Russian gas exports to Europe has risen significantly. So too has the European Central Bank's (ECB) willingness to pursue a tighter monetary policy. The Federal Reserve's (Fed) position has also shifted. It is repeatedly communicating its commitment to curb high inflation and rising inflation expectations by raising interest rates, even if doing so might cause recession. The darkening of the global economic outlook is dramatic. In a short space of time far higher inflation and lower growth –  even, possibly, recession – have become possible.

A much darker picture, but not everything has become less clear. There is now much less doubt about central banks’ future moves – at least for the current year – than there was in the spring. But Russian energy supplies have become a major concern for western Europe. In mid-June, Gazprom reduced delivery volumes running through Nord Stream 1 by a total of 60%[1] in two steps. In response to the technical problems this created, German Economics Minister Robert Habeck called for the second (of three) escalation stages of the Gas Emergency Plan. We can only speculate about Moscow's intentions. Our assumption is that Russia will continue to use its gas exports as a tactical means of exerting pressure on Europe. Russia's leadership appears to believe at present that it can obtain the greatest benefit by keeping a sustained and sizable cap on its energy exports as a threat while playing European states off against each other through supply restrictions on individual countries.

...and the prospects for growth and markets

The shift by European and U.S. central banks left a clear mark on the markets in June. The S&P 500 (and the MSCI World AC) slid into bear market territory (a drop from peak of over 20%), while yields on European and U.S. government bonds made another sharp move higher.[2] The bond market in particular is struggling to decide what to worry about more: high inflation, or emerging recession fears. With the central banks clearly prioritizing the inflation fight, the global economy certainly looks set to cool down significantly – unless restrictive monetary policy begins to soften. We do not rule out a mild recession in the U.S. in late 2022 and early 2023. Investors are worried because inflation has now boxed in the central banks: they have no room to adopt policies to bolster markets –  the so-called Fed Put is dead. And not only are policy rates certain to rise further. Quantitative tightening – reduction in the Fed's hugely expanded balance sheet – which started this month, appears likely  to affect market liquidity and valuations, and in a hard to predict way.

Given the new aggression of the central banks, we have brought forward our rate hike path and now expect U.S. policy rates to be as high as 3.25-3.5% by year-end – above the "neutral" rate and likely very close to the peak, or even possibly the peak, of this rate hike cycle. In turn, we expect the ECB to raise the deposit rate to 2% and the refinancing rate to 2.5% within twelve months. The ECB is also likely to unveil tools in the coming weeks that could counteract a widening of risk premiums on sovereign bonds in the so-called eurozone periphery, especially Italy.

In our baseline scenario we still expect economic growth of close to 3% for the Eurozone this year while the U.S. may slow to just 2% this year and 0.8% next year. This is partly because Europe’s upturn started later and more slowly than America’s. And while most fiscal packages in the U.S. have already been implemented, some European programs are only now really starting to take effect. Another factor is the stronger dollar and the fact that deteriorating financing conditions are having a greater impact on economic activity in the U.S. than in Europe. The biggest risk for Europe is certainly natural gas supply. In the event of a complete shutdown in Russian gas supplies (and in the absence of compensatory measures), we would expect growth in the Eurozone to reach only 2% this year and to fall by 1.4% in 2023. In a worst-case scenario, with soaring energy prices, inflation could reach double digits. In our baseline scenario, however, we have only slightly adjusted up our inflation forecasts for the U.S. and Europe this year and next.

For China, we expect a very weak second quarter, with a decline in growth compared to the first quarter. Consumer spending is expected to remain subdued but we foresee an improvement in the second half of the year thanks to government stimulus measures, so that growth of close to 4% could be achieved for the year as a whole.        

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Adjustments to key interest rates, growth and target yields

Fixed Income & Currencies:

We are broadly maintaining our forecasts for U.S. government bond yields, as there has been little change to the outlook for the coming 12 months as of June 2023. The 2 year to 10 year yield curve is expected to remain very flat. Market-implied inflation expectations have been declining for several weeks, which seems to confirm that the Fed's tightening policy is beginning to convince markets. Based on our significantly increased key rate forecasts for the ECB, we have raised our forecasts for 2-year Bund yields to 2% and 10y yields to 2.25%. Corporate bonds offer an attractive yield overall at current levels, although risk premiums could run out further. However, we do not expect risk premiums (whether U.S. or European, investment grade or high yield) to move back to the low levels of last year in the foreseeable future. We see major risks for global markets emanating from the Japanese bond market. If the Bank of Japan (BoJ) is no longer able or willing to counter the upward pressure on yields in Japan there could be a surge in bond yields outside Japan, too. We continue to see the Dollar at 1.10 against the Euro, with some possible upside for the Euro in the longer term, but gas import risk could continue to weigh on the euro for the time being.

Equities:

We are reducing our 12-month price targets for the various regional equity indices by 5 to 7%. As the second quarter reporting season begins, we are convinced we have already seen the peak in companies' operating profit margins across the board. We still expect single-digit earnings growth this year but stagnation in 2023 and 2024, particularly in developed markets. Our forecast is below consensus estimates, which we expect to be revised down later in the year. But a decline in market volatility might at least start to have a stabilizing effect on stock indexes. We view the current levels of over 30 for the S&P 500-based VIX (the volatility index) to be unsustainable.

Alternatives:

We maintain our forecast for the oil price of Brent crude at $110 a barrel over the next 12 months as we believe that cautiously optimistic forecasts for increases in production capacity will be sufficient to meet somewhat weaker than initially expected demand. We are somewhat more pessimistic about gold due to the stronger and faster than expected rise in real interest rates – even though the current elevated geopolitical risk premium is, unfortunately, likely to remain.

In illiquid assets we see the first signs of a cooling in transaction prices in the real estate sector, even if rents continue to rise or are at least stable. Above all in Europe and Asia's lower quality segment, higher refinancing costs are having a negative impact on prices. By contrast, the Japanese market is proving robust, thanks in part to rising international interest. In the U.S. properties with (flexibly) rising rents remain in high demand. However, we expect yields to decline overall due to higher interest rates and weaker growth, though we do not fear a major correction.

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Macro forecasts

GDP growth (in %, year-on-year)

2022F

2023F

United States 2.0 0.8
Eurozone 2.9 1.8
United Kingdom 3.5 0.7
Japan 1.7 1.8
China 3.8 5.3


Benchmark rates[3] in %

Current[2]

June 2023F

United States 1.50-1.75 3.25-3.50
Eurozone -0.50 2.00
United Kingdom 1.25 2.50
Japan 0.00 0.00
China 3.70 3.60


Consumer price inflation (in %, year-on-year)

2022F

2023F

United States[4] 4.9 3.1
Eurozone 8.0 3.7
United Kingdom 8.7 5.3
Japan 1.9 1.7
China 2.3 2.3


Commodities

Current[2]

June 2023F

Gold 1,825 1,950
Oil (WTI 12M Forward) 118 110

Asses-class forecast


Rates

Current

June 2023F

U.S. Treasuries (2-year)

3.12%

3.00%

U.S. Treasuries (10-year)

3.22%

3.25%

U.S. Treasuries (30-year)

3.33%

3.40%

German Bunds (2-year)

0.96%

2.00%

German Bunds (10-year)

1.64%

2.25%

German Bunds (30-year)

1.84%

2.50%

UK Gilts (10-year)

2.84%

2.70%

Japanese government
bonds (2-year)

-0.05%

0.00%

Japanese government
bonds (10-year)

0.24%

0.20%



Spreads

Current

June 2023F

Spain (10-year)[5]

109bp

110bp

Italy (10-year)[5]

193bp

180bp

U.S. investment grade[6]

137bp

180bp

U.S. high yield[6]

502bp

570bp

Euro investment grade[5]

166bp

150bp

Euro high yield[5]

512bp

505bp

Asia credit

318bp

320bp

Emerging-market credit

377bp

370bp

Emerging-market
sovereigns

504bp

500bp


Equities

Current

June 2023F

United States (S&P 500)

3,916

4,200

Europe (Stoxx Europe 600)

418

430

Eurozone (Euro Stoxx 50)

3,565

3,650

Germany (Dax)

13,295

13,900

Switzerland (SMI)

10,851

11,250

United Kingdom (FTSE 100)

7,348

7,250

Emerging Markets (MSCI Emerging Markets Index)

1,028

1,060

Asia ex Japan (MSCI AC Asia ex Japan Index)

670

695

Japan (MSCI Japan Index)

1,158

1,150



Currencies

Current

June 2023F

EUR vs. USD

1.05

1.10

USD vs. JPY

136

130

EUR vs. GBP

0.86

0.92

GBP vs. USD

1.22

1.20

USD vs. CNY

6.70

6.75

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Discover more

1. https://www.businessinsider.de/politik/deutschland/gazprom-liefert-60-prozent-weniger-gas-nach-deutschland-bundesnetzagentur-schliesst-kompletten-lieferstopp-nicht-aus/

2. Source: Bloomberg Finance L.P.; as of 6/28/22

3. U.S.: Federal Funds Rate, Eurozone: Deposit rate, UK: Repo rate, Japan: Overnight call rate, China: 1 year lending rate

4. core rate, personal consumption expenditure

5. Spread over German Bunds

6. Spread over U.S. Treasuries

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