Des Lawrence, senior investment strategist at State Street Global Advisors, thinks the market may have gotten carried away with expectations for interest-rate hikes from central banks in both in the U.S. and the U.K. While fed fund futures suggests as many as seven rate hikes this year, Lawrence says the Federal Reserve may end up doing just two or three increases.
“The economy is starting to roll over,” Lawrence said. “We’ve gone past the peak in economic output, and we’ve gone past the peak in both monetary and fiscal stimulus,” he says. What’s missing, he says, is the peak in inflation, but in the second half of the year some elements driving prices higher will fall out of the comparisons.
Roughly two percentage points of the 7.5% year-over-year climb in inflation is attributable to energy. “Unless we get multiple shocks that embed themselves in the next couple of quarters, that by construction will roll out, so I think that’s the difference between us and the market.”
Lawrence says the potential for the Fed and other central banks to overreact is a “gray swan,” but he expects a soft landing. “People put a lot of credibility and faith in central banks, and you’ve seen from [Bank of England Governor Andrew] Bailey, they don’t always get their speeches perfect, they make mistakes in interviews, they make mistakes as a collective group, and then they move back from them,” he said.
“But we don’t see that as something that’s a base case that causes economies to nosedive into a recession,” he said. The U.S. consumer still has significant levels of savings, and across corporate America, debt levels are pretty good and have been termed out, he says.
He does think the current volatility
will continue owing to the interest-rate uncertainty. “When you look at equity markets, they’re not cheap,” he adds, though he thinks single-digit percentage returns are possible as earnings will allow companies to grow into their valuations. The S&P 500
has dropped 6% this year.
Lawrence helps clients design multi-asset strategies. In a 60/40 portfolio, investors may want to find inflation protection in the growth part of the portfolio, as inflation-protected securities, particularly in Europe, are expensive. “In a broadly challenging regime for bonds there is scope to enhance the inflation credentials on the growth side (60) using commodities and natural resource stocks in particular,” he said. Investment-grade credit, high yield and emerging market debt can also help lift yield, but they are all by nature susceptible to rising inflation.
Despite the weak performance so far in 2022, he says there’s merit in U.S. investors holding longer-dated Treasurys to protect against an equity market correction. It also may be worthwhile for European investors to buy U.S. Treasurys even with the currency risk, as the U.S. dollar
attracts inflows in severe risk-off episodes. The Swiss franc, the yen and other assets like gold also can be useful for European investors to consider as tail-risk strategies.
The S&P U.S. Treasury bond current 10-year index has dropped 5% this year.