MonthlyFlow - September 2022

       There wasn’t going to be a pivot:
  • The FED crushed any hope of a "dovish pivot", but this should not be a surprise

  • If disinflation continues, markets should move higher into the end of the year

  • We remain relatively cautious but believe the outlook for risk assets has improved

A big part of this summer’s rally was based on the growing expectation that the Federal Reserve was going to “pivot”. That is, investors believed the Fed was going to turn more dovish and worry about growth instead of inflation. That hope was slashed by Mr. Powell’s Jackson Hole speech, where he reaffirmed the Fed’s intention of flighting inflation even if it induces economic pain, and that the Fed was a long way from being able to declare victory over inflation. Indeed, one month of softer inflation does not make a trend, and, at 8.5% headline CPI year-over-year, we are still far from the Fed’s 2% target.

However, this doesn’t mean the summer’s rally is destined to fail. A number of factors suggest that the rally could resume, even if the road upwards proves bumpy. First, the breadth of the rally was impressive – it was not led just by technology. Second, sentiment and positioning remain extremely negative. Few participated in the rally, short positions actually increased, and cash levels are still very elevated. Sentiment is by no means bullish. Finally, the rally started before the July CPI print or the more dovish July FOMC minutes. Certainly, these factors added to the momentum, but they didn’t ignite the initial move higher.

In addition, while the Fed is not pivoting – and was never going to pivot this soon – we are probably past the more aggressive part of the tightening cycle. The Fed will continue to hike interest rates, but at a more normal pace, especially after September. However, interest rate cuts anticipated for 2023 are unlikely, with the Fed staying higher for longer to make sure inflation continues to fall and long-term inflation expectations remain anchored. As such, we believe that markets can move higher into the end of the year, though not without corrections. September is notoriously weak, but disinflation signals continue to come in, suggesting better inflation news over the coming months, which should assuage both the Fed and the market’s fears.

Of course, markets will be laser-focused on inflation data. But the labor market requires as much attention. If the labor market does not soften, it could push the Fed to tighten more than is currently priced in, raising fears of a policy-induced recession for 2023. This is not our base case, but something to keep in mind. For now, we choose to remain somewhat cautious, but maintain an exposure to risk assets. Even if volatility persists, growth is holding up, earnings should hold up and equity markets should be able to move higher over the coming months.

The situation in Europe is more complex, with high and still-rising inflation mainly due to energy prices, which central banks have little control over. Nonetheless, policymakers will need to work to bring inflation down, a difficult conundrum given the ongoing energy crisis and the more pronounced risk of recession for the Old Continent. While markets have help up so far, the euro is bearing the brunt of the pain, with little prospect for a strong recovery in the short term.

China has its own challenges, with a sharp slowdown in the housing market and little consumer appetite to jump-start retail sales. Policymakers are adding to stimulus measures, but growth is still likely to disappoint in the coming quarters, especially as a lot of stimulus is aimed at infrastructure. Investors also remain on their guard with regulatory and lockdown risks still present, suggesting a cautious approach towards emerging markets as a whole.


After a big summer rally, markets took a breather following a more hawkish tone from Mr. Powell
and a reaffirmation by the Fed that it will continue to hike interest rates to bring inflation
down, even if growth slows sharply. While some believe the move higher will prove short-lived, we
expect ongoing disinflation indicators to boost markets over the coming months, showing that
the Fed is past the more aggressive part of its tightening cycle. With positioning very light and
sentiment very negative, a lot of bad news is priced in already, setting a higher bar to break
below the June lows again. Nonetheless, the move higher will not be without bumps, growth
fears will not vanish, and we maintain a relatively cautious stance. We expect technology to resume outperforming as post-Jackson Hole market fears subside, leading a rebound into the end of the year.
Defensives should continue to do well, but cyclicals should eventually recover with risk appetite. Europe is likely to remain under pressure compared to the US given energy risks and the ongoing conflict in the Ukraine. Emerging markets remain tied to China, where the outlook is only mildly improving.

Fixed IncomeFixed income markets have proven relatively stable, reacting much less to Mr. Powell’s Jackson Hole speech than equity markets. While no Fed pivot is coming, we are probably past peak inflation fears, peak hawkishness, and peak tightening fears, suggesting the big part of the move higher in yields should be behind us. As such, we have a more balanced allocation between sovereigns and credit, even if another spike in yields could happen. Spreads have recovered and are pointing more towards a growth scare than an outright recession. Still, we maintain a preference for investment grade over high yield, as growth fears are not behind us.


Even though we are likely near a peak for the dollar, the greenback is unlikely to retreat much
as growth and interest rate differentials remain supportive for USD versus other major
currencies, and haven flows would pick up if grows slows too much. Still, an improvement in
risk appetite should bring some support to the euro, as a lot of bad news is already baked in in
terms of growth and energy risks. Sterling should recover as the UK political landscape becomes
clearer, though a hard-line Brexiteer PM could weigh on confidence, while JPY may not weaken
much from here as the Bank of Japan is holding steady. Emerging markets have been mixed, but
a stabilisation in RMB should help and USD weakness would too..

CommoditiesCommodity prices remain well below the year’s highs, though some have shown signs of stabilisation in recent weeks. Industrial commodities like copper have stabilised, though growth concerns suggest they might not spike again. Gold remains under pressure as the dollar remains strong, though we may be getting closer to a peak in USD and a stabilisation could materialise. Oil prices have moved up again, but they remain in a range below USD100 per barrel. Given that supply remains tight, that OPEC+ is even considering reducing output – likely if Iran oil comes back online – and that the war in Ukraine is likely to last, prices are unlikely to drop sharply, even if growth fears increase.

Sentiment towards the cryptocurrency markets remains subdued, with major currencies regaining some ground, but failing to push meaningfully higher over the summer. Tightening expectations and pressure on equities have not helped sentiment, with many waiting for stronger signals to dive back in. As such, it might take time for sentiment to recover and for flows to resume, but broad adoption should eventually continue.


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