US inflation – No top in sight.
January US CPI came out at 7.5% yoy, making new highs. The energy component is still important, but not the only nor the main driver of inflation at this point. Rent inflation remains elevated, and used vehicles and service pressure is not abating. Core pressure thus remains elevated, with CPI ex food and energy recording a 6% yoy increase. The end of Covid restrictions will probably help some relaxation of inflation pressures in Spring, but it is now clear the inflation top is not close as the Fed was previously expecting. Inflation worries are rising dramatically within the US political spectrum, and a strong reaction from the Fed is now warranted. An emergency meeting to hike rates is probably not on the table, but 5-6 hikes this year are now likely. US rates accelerated their increase this week, with the front-end moving 20bp on Wednesday, the highest daily move in the past two years. Market pricing of hikes is now appropriate (even on the high side), but the long-end and broad DM credit have room to suffer more, especially in an environment of high rates volatility and a broad absence of outflows (so far). We thus think duration risk is still to hedge at global level and credit spreads are not attractive yet. A high February print just ahead the March Fed meeting is likely to trigger a renewed wave of rates fears.
Periphery spreads – Back to old habits.
The recent hawkish ECB turn triggered a renewed pressure on periphery spreads, after almost two years of low volatility. In February, yields on Italian and Greek debt are 70bp wider, vs 50bp in Spain and Portugal, and just 30bp in Germany. A correlation between debt levels and yield moves is thus emerging back, after QE broke the relation in post-pandemic markets. We believe the correlation will keep turning stronger over the next few months, with pressure on periphery spreads set to intensify. As the ECB exits QE, the burden of absorbing abundant government debt issuance will move back to investors. As such, higher deficit countries will see more pressure, and sensitivity to local politics and news on fiscal policy will increase. Periphery spreads are still 200bp below 2018 highs, and more than 300bp prevailing levels of inflation. Moreover, Italy has important elections coming up in 2023, arguably when the level of interest rates in the Euro Area will be much higher than currently. We remain cautious on Euro Area government debt, considering it one of the potential “fault lines” in the new post-QE / high inflation world.
Russia-Ukraine – Pivotal moment approaching.
The pivotal moment for the Russia-Ukraine crisis is arguably approaching. Last week, in a series of press conferences, US officials have warned the time of an actual Russian invasion of Ukraine may be close. The warnings have been followed by a round of talks between world leaders over the weekend, including a phone call between US President Biden and Russia President Putin. The next ten days will likely be pivotal, as winter Olympics end on February 20th, and Russian military drills in Belarus are set to terminate the same week. Any important military decision is thus likely to be taken in this time period, especially as the ground in Eastern Ukraine worsens meaningfully starting mid-March. In terms of asset prices, the main consequence of an invasion would be a strong increase in oil and energy prices, as consequent sanctions on Russia would make global access to energy scarcer. The impact of a crisis may thus ultimately be inflationary, with increased medium-term pressure on rates (after potentially some tighter rates initially on a broad risk off move). Equity markets and broader risk would initially selloff, but the move may be short-lived, as the US imports from Russia are now close to zero and Russia exports to China won’t be affected. The outlook for global growth may thus not change much even on prolonged tensions. Emerging market debt and equity would underperform, given Russia/Ukraine presence in the indexes and the contagion effects on other markets.
Alberto Gallo – Portfolio Manager Global Credit Opportunities Fund
Gabriele Foà – Portfolio Manager Global Credit Opportunities Fund
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