The second quarter of 2022 has been an unmitigated disaster for financial markets. The world was hit by a one-two punch. Inflation has skyrocketed, and global growth has slowed. Central banks have responded by making inflation their one and only priority. The third quarter of 2022 is shaping up to be the summer of discontent.
Contributors: Ajay Rajadhyaksha & Amrut Nashikkar
23 Jun 2022
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1. There are mounting worries about growth
The world is slowing quickly. Runaway energy and food prices, negative real wage growth and zero-COVID lockdowns have all taken a toll. Our Research analysts expect China to post a sharply negative second-quarter GDP print and the euro area to enter a recession from the fourth quarter.
The US has been a bright spot, but is now flashing warning signs. Housing activity is in free-fall after the massive rise in mortgage rates, and there are signs that US consumers are pulling back after a strong start to the year. Our analysts have therefore made a big reduction in their 2023 GDP growth forecast, to just 1.1%.
Overall, they expect advanced economies to grow 2.5% in calendar year 2022, a sharp climb-down from the 5.2% pace of 2021. There are downside risks to even this forecast, primarily from further lockdowns in China or if Russian natural gas exports to Europe slow.
2. Central banks won't ride to the rescue
For the past several business cycles, investors could count on central banks adjusting their stance if growth were slowing too quickly or financial conditions tightening too much. Not this time, according to our analysts. They note spot inflation is simply too high and inflation forecasts have been too wrong for too long.
The Fed’s latest economic forecast is a case in point. The US central bank expects the jobless rate to keep rising for the next three years, yet forecasts an increase in interest rates well above its so-called “neutral” level. This suggests a commitment to fighting inflation to the exclusion of all else.
The ECB is similar; far more of Europe’s inflation is driven by demand, and nominal wages are remarkably low compared with inflation. But it is clear that in Europe, too, the hawks are expected to remain in charge for a while.
3. It is too early to overweight risk assets, despite the big pullback in Q2
As of the publication of this article, the S&P 500 was down about 17% for the quarter and the Nasdaq 22%.
Our analysts believe a sustained rally would require signs not only that growth is stabilizing, but also that inflation is definitively turning, to the point that it eases pressure on central banks. They believe this looks unlikely as the third quarter approaches.
There are also a number of downside risks that have not been realized or priced in, such as further cuts to Russia’s gas supplies to Europe or a ramping-up of COVID testing in China. Our analysts remain worried about the speed of the drop in US housing activity and the ripple effects from it.
So they are focused on looking at sectors where investors can ‘hide’ for some time. But if asked to choose a side, they would favour longer fixed income over equities at this point. For the first time in over two years, and very hesitantly, they are recommending owning bonds over stocks.
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About the experts
Global Chairman of Research
Ajay Rajadhyaksha is Global Chairman of Research at Barclays, based in New York. He drives the global macro research and strategy effort including economics, rates, FX, commodities, emerging markets, and asset allocation. Since joining Barclays in 2005, Ajay has held various positions, including Head of Macro Research, Co-Head of FICC Research and, before that, Head of US Fixed Income Research and US and European Securitised Research.
Managing Director, Fixed Income Strategy
Amrut Nashikkar is a Managing Director in the Fixed Income Strategy team at Barclays based in New York, covering interest rate derivatives with a focus on interest rate volatility and the Libor transition. Amrut joined Barclays in 2008 from Lehman Brothers, where he was an interest rate strategist. Prior to that, he taught at New York University. Amrut graduated with a PhD in finance from New York University. He also holds a management degree from the Indian Institute of Management, Ahmedabad, and an undergraduate degree in engineering from the Indian Institute of Technology, Kharagpur.