Vontobel Multi Asset Boutique
As this publication returns to the stove, shifts in the economy and markets have continued to simmer.
In the blink of a summer’s eye, circumstances have changed, stirring the pot even as the topics on investors’ minds remain the same: interest rates, inflation, and the will-there-won’t-there debate around a recession. The US Federal Reserve’s economists dropped their recession projections as the economy has proven surprisingly resilient. Many investors now lean toward anticipating a soft landing, along with the possibility of elevated rates for years to come.
We still believe in a recession – the data point to one – but pushed back to around year-end. The Inflation Reduction Act has provided quite a bit of stimulus, with consumers going strong and seeming eager to spend in a last hurrah before an anticipated slowdown and a labor market that has kept providing surprises, including a host of wage negotiations.
Intuitively, no landing sounds great (who wants a recession?) but that scenario probably wouldn’t tame inflation, and the Fed would likely have to keep hiking rates with the risk of breaking all sorts of things. On the other side of the spectrum, a deep recession sparked by an overly zealous Fed would see a domino effect of companies slashing investments, consumers curtailing their spending, and a spike in corporate and personal default rates. The Fed would feel the need to cut rates aggressively to save the economy – but working from behind the curve would have little immediate impact and carry the risk of inflation flaring back up again. A soft landing could represent the best-case scenario here, as it would generate enough demand destruction to get inflation under control, allowing central banks to pause and maybe even cut rates if necessary. It would also pave the way for a non-volatile way forward for asset prices.
Translating the various scenarios into one analogy for investors, the current situation calls for finding just the right temperature, much like in the fairytale in which Goldilocks finally finds the third bowl of the three bears’ porridge to her liking, being neither too hot nor too cold, but just right.
Elsewhere, the economy is grappling with weak points. China’s recovery, which many investors have pinned their hopes on to spur global growth, has stalled. The disappointing economic momentum underscores our view that Beijing needs to provide a higher degree of stimulus – though we do not expect the big bazooka many are waiting for.
Whether a recession ends up occurring or not, a diversified portfolio can help with market volatility. At our most recent Investment Committee meeting, we’ve reduced risk assets and added a pinch of cash equivalent holdings. In this Investors’ Outlook, read up on the dynamics in fixed income, oil, and find a checklist for inflation drivers.
We’re happy to share our bowl of porridge with you. And to try to make it just right.