Over the last month, markets lacked a clear direction owing to US banking sector stress, uncertainty regarding the US debt ceiling, and signs of economic deceleration amid tightening of credit conditions. However, a key factor supported markets in the form of Q1 earnings, which came in better than expected in the US. The Fed’s pause in its sharp rate hike cycle was also supportive.
Now, markets are pricing in a rosy scenario in which economic deceleration will force the Fed to cut rates in 2023, but we believe the Fed will stay on hold for 2023 and cut rates only in 2024. Four themes reinforce our cautious stance in this environment:
- Inflation is cooling slowly, and some signs of inflation psychology are showing up, as highlighted in the chart below. Given uncertainty regarding inflation expectations, the likelihood that Fed will cut rates any time soon is low.
- The US economy is cooling down. GDP is expected to start slowing substantially in Q2, with a contraction seen in 2H23. The resilience of the US consumer is the key variable to watch.
- China reopening is playing out, but the road is bumpy. The rebound is tilted towards internal demand, while the manufacturing side is weak and uncertainty on housing figures has increased.
- Markets are too complacent and are ignoring the wall of risks. There are signs of a gaps between fundamentals and excessive valuations in many areas, such as US equities and HY.
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