The first sequence of the double bear markets (in equities and long-term bonds) adjusting to the end of easy money and rising inflation is almost complete. Now, the narrative has changed, with a shift in focus to deceleration of growth vs fears of inflation.
The three main themes that should be monitored are:
- Lower growth, high inflation: DM in a stagflationary scenario with divergences and potential effects of gas rationing on European GDP growth.
- Earnings expectations could still come down. Current market pricing is still coherent with a return to a normal inflation regime and not entirely pricing in a profit recession. In a capitulation phase, markets should anticipate the worst, with either stronger EPS drawdown or lower prices (or both), but we don’t think we’re there yet.
- Dollar rally: room to continue. With no changes in the Fed stance, we see downside risks to our EUR/USD targets for year-end, with a possible downside level at 0.94 while the six-month target remains around parity. Recession or a higher probability of recession would be positive for the US dollar as long as the Fed stays hawkish.
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