Investors’ Outlook: A crude awakening

A crude awakening

The month of September delivered a bolt from the blue to market dynamics.

In addition to investors’ existing concerns about inflation, a recession, and central banks possibly making a mistake by hiking interest rates too high and for too long, the global economy and policymakers have been thrown an extra ball to juggle: surging oil prices.

Saudi Arabia and Russia wielded their power, extending curbs on oil production through December, a reflection of the ability of current and prospective BRICS economies to stand up and make themselves heard by controlling energy prices and reminding us just how thin the line is between commodities and politics.

While risk assets are still fairly well supported, oil’s spike could turn into a cold shower for central bankers, who are starting to view inflation as sufficiently tamed to allow for breaks from the most aggressive interest-rate increases in four decades.

The biggest question revolves around what the impact will be, as the current picture is framed differently this time around. Will soaring energy prices kill the progress made on containing inflation and reignite a rise in consumer prices? Will it weigh on economic growth? And is stagflation, the word nobody wants to hear, back on the table as an increasing number of market observers have uttered it?

While we aren’t (yet) too concerned about a significant price rise, the oil surge has already left its mark on the latest inflation data. But we believe central banks will look past these temporary price increases – at least for now – as they mostly focus on core inflation, which has come down. The US Federal Reserve held rates at its September meeting, and while Chair Jerome Powell signaled that rate hikes are nearing an end, he also hinted at a higher-for-longer environment next year as a soft landing looks increasingly feasible.

We, however, continue to expect a recession as a Christmas present or a New Year’s hangover, and the first cuts later in 2024. Fighting inflation has its price, and the economy is already showing signs of weakening. We also believe that investors’ main focus will shift from inflation to growth and the coming recession, especially as the factors that have propped up the economy so far, such as pandemic savings, a surprisingly resilient labor market, and fiscal stimulus, slowly fade away.  

In this Investors’ Outlook, our colleagues in the Conviction Equities Boutique raise the question of whether it’s time to separate China from a single emerging-market equities allocation to a stand-alone stance as they analyze the paradox of it being of being simultaneously dominant and underrepresented. You can also get a clearer picture on US fiscal spending and our decision to refrain from making any changes to our positioning for now.

Whether oil’s run is short-lived or more persistent, we believe now is the time to keep a steady hand as jolts ripple through the system.