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Central banks starting to cruise at different speeds

Cross asset weekly pic
Yesterday’s decision of the Bank of England to reduce its monthly purchase volume is a timely wake-up call that monetary policy is past its most expansionary period. Yet, the speed and the timing at which central banks will reduce their policy is set to vary significantly. True, some inflation indicators point to a rising price pressure globally. Bottlenecks in the manufacturing sector, for example, are turning into a more important constraint to growth than the lack of demand. They also lead to higher input costs and increase the pricing power of companies in countries that ease lockdown measures. Another driver of global reflation are rising food and energy prices. However, for prices to rise sustainably, the labour market needs to recover. Only higher wages and higher medium-term inflation expectations secure inflation rates closer to central banks’ targets. Neither in the euro area, nor in Switzerland are these conditions yet in sight. The situation is different in the US though. Fed officials have argued time and again that the coming increase in inflation will be transitory, but there is growing evidence that inflation is unlikely to drop back to previous lows. Inflation expectations have already risen substantially and if wages continue to accelerate, the Fed will find it hard to maintain its dovish stance.
The US equity market is exposed to some transitory weakness in the date. The ISM manufacturing for April disappointed by steeply dropping from its March level. We think this is significant given that ISM momentum has a very tight correlation with US equity performance. In the past 30 years, the immediate aftermath of ISM peaks was usually marked by quite an anaemic market environment. Global equities, on average, dropped by 0.5% over the following three months. On the back of this observation and considering current valuation levels, we believe the balance of risk has further shifted to the downside in the short term. While we continue to see single-digit upside for US and global equities until year-end, it may make sense to tread more cautiously in the coming weeks.

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