ECB – Last dove flying away
The first ECB meeting of 2022 turned carrying a strong hawkish surprise. While no policy change was introduced, communication changed drastically. At the press conference, President Lagarde refused to rule out hikes in 2022, making rates decisions data dependent and attaching a high weight to the March forecast revision. Further, the language about inflation changed, with the “transitory” narrative quickly replaced by “concerns about potential upside risks”. The two together suggest the inflation path will be revised strongly higher in March projections, justifying hikes in 4Q22. Finally, the ECB also stressed that hikes may take place only after tapering has been completed. Given the hawkish comments on inflation, this suggests purchases may be fully phased off before summer, and well before current guidance would suggest. A hawkish message triggered a big repricing in European rates. 10y bunds are now firmly in positive territory, with around 20bp yield, and the BTP-Bund spread now hovers around 160bp, the highest level of the past two years. Markets are now pricing 50bp of hikes in 2022, with the cycle beginning in June, in line with what priced for the Fed. In the context of strong and accelerating inflation, Eurozone market rates may need to continue re-pricing. The ongoing move in core and European periphery government debt can thus continue. Credit has started moving recently, with CDS quickly reaching levels first seen in 2018. Cash bonds are being more resilient, but gradual outflows will weigh on those too. We don’t see rates and government bonds as interesting yet given the level of inflation. On credit, we start seeing some areas as pricing in weakness, but we don’t think it’s the time to start buying yet. Bond investors will need to be cautious and selective for the rest of 2022, especially in the Eurozone.
Bank of England – Inflation worries
Last week, the Bank of England came across with a worried message about inflation. The central bank hiked rates 25bp to 0.5%, as expected by the market, but almost half of the committee voted for a 50bp hike, uncommon in developed market central banks. Also, corporate bond purchases, introduced as an easing measure during the pandemic, were unwound down to zero starting next month. UK inflation is hovering between 5% and 6%, with core components showing clear signs of increase right now, on top of energy. Wage pressure is increasing markedly, and food prices show now annual increases between 5% and 15%, depending on the category. Inflation concerns are thus very strong, as recent comments by central banker Bailey suggest. We remain overall wary on UK inflation, noting that Brexit impact adds up to an easy monetary policy. The BoE is now reacting, but communication has been very volatile over the past few months, with a dovish turn in November followed by a quick hawkish move, and real interest rates comparable to European levels despite higher inflation and a stronger economy. We thus suspect communication on interest rates and monetary policy will need to turn more hawkish over the next few weeks, with a consequent continuation of the ongoing move on front-end rates and gilts.
US tech – Inflation casualty
US tech had a challenging week, with large caps in the sector down 20-25% on relatively small revisions in earnings guidance. The Nasdaq index is now down 12% ytd, after strong outperformance in 2020 and 2021. We think US tech stocks well illustrates the case of “inflation casualty”. Valuations in the sector have been increasing massively over the past three years due to low rates and increasing QE, as the sector was the only one offering decent earnings growth to investors in a zero rates / zero growth world. Higher inflation and higher rates will thus trigger a strong repricing of tech multiples, and a likely re-assessment of growth potential of large caps and fresh IPOs in the index. The US market is still trading at a PE 25% above the historical average, despite the January correcting, suggesting more downside into the upcoming Fed tightening cycle. We think “paper assets” and “bubble assets” will continue to be under pressure in 2022, on both higher inflation and higher real interest rates. US tech is the first and more evident case, but investors should turn their attention also to areas of overvaluation in European credit, IG credit, and emerging market debt, as easy money gradually pushed valuations up in these sectors too over the past three years.
Alberto Gallo – Portfolio Manager Global Credit Opportunities Fund
Gabriele Foà – Portfolio Manager Global Credit Opportunities Fund
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