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Market Insights – February 14, 2022

Each week, our Investment team shares its market views with you !

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Essentials

The European Central Bank’s change of tone has sparked fears about peripheral countries’ debt levels, causing yield spreads to widen between these countries and Germany. This trend could well continue, but it’s worth noting that ongoing rock-bottom interest rates and strong economic growth could help to bring down these debt levels. 

There have been further signs of monetary easing from the People’s Bank of China. Spurred by recent cuts to benchmark interest rates and reserve requirements, credit growth – a key economic indicator – picked up in January and beat market expectations. 

Commodities continue to fare well, driven by tight supply, high inflation and investor’s increasingly cautious stance on risk assets. Gold seems to have woken up at last, roused by its safe-haven status. And oil prices have continued to gain ground, getting a further boost from the uncertainty about the situation in Ukraine.

Will US long-term rates stop at 2%?

Not a week goes by without some inflation-related surprises. At end-January, US consumer prices were up 7.5% year on year, a level not seen since the early 1980s. It is with a certain astonishment that we discovered this figure, even though we have for many months been sounding the alarm about the risk of inflation being higher and more persistent than expected in the States. The consumer price index doesn’t look like it will start heading downwards anytime soon.

That’s firstly because energy prices continue to rise. But it’s also because wages have gone up by more than 5% year on year, sparking fears of a vicious wage-price spiral. Europe hasn’t been affected by soaring wages yet, which suggests that inflation may be more transitory on this side of the Atlantic.

We can’t say that Milton Friedman, who won the Nobel Prize in Economics in 1976, didn’t warn us about all this. He famously said that “Inflation is always and everywhere a monetary phenomenon”. He believed that if the money supply grew faster than economic output, prices would invariably rise. Since the 2008 financial crisis, central banks have been hard at work creating money. And they really doubled down on their efforts in response to the pandemic. All major central banks adopted this policy, which caused their balance sheets to balloon and flooded the financial system with cash.

The US Federal Reserve’s (Fed) balance sheet is now twice as big as it was in early 2020 and ten times the size it was at the start of the subprime crisis. It was inevitable that all this cash would awaken inflation from its long slumber. Central banks, and especially the Fed, now have to try and get the genie back in the bottle without breaking it. In other words, they need to tighten monetary policy enough to rein in inflation without derailing economic growth.

How fast and far interest rates head upwards on both short- and long-term bonds will be decisive. For the moment, the rate hikes are not going up enough to knock the economy off track, but are enough to spark fear among investors and cause volatility on the stock markets.

Japan – time to break the piggy bank

Japan had an eventful second half of 2021. It hosted the Olympic Games in the middle of a pandemic, elected a new prime minister, ended its state of emergency and gradually began reopening its economy.

However, despite the generosity of the Bank of Japan (BoJ) from the start of the pandemic, the country’s economic recovery is lagging behind that of other industrialised nations. That’s because Japan’s vaccine rollout has been slow, preventing consumer spending from returning to normal.

Today, Japanese households are ready to spend their accumulated savings as soon as COVID-19 restrictions are eased, and the ensuing rebound in the services sector should provide a substantial boost to GDP growth. We expect growth to reach around 3% in 2022 – a rate Japan hasn’t experienced in nearly a decade. The uptick in Japanese output this year will contrast starkly with the slowdown expected in most economies, especially in the US and Europe.

At the same time, inflation won’t put the same upward pressure on Japanese interest rates. Rising rates were quickly kept in check by the BoJ’s decision to defend its 0.25% bond yield target. What’s more, the yen was one of Asia’s weakest currencies in 2021, giving Japan the most suspicious macro it’s seen in years.

This promising outlook has only reinforced our bullish stance on Japanese stocks. They should keep catching up in 2022, unless a new variant emerges or there’s an error of judgement on the geopolitical front. 

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