Weekly View – End of an era

After the death of Queen Elizabeth, the reign of King Charles III starts at a particularly challenging time for the UK. The new Prime Minister, Liz Truss, is targeting average annual growth of 2.5%—to be delivered via tax cuts and deregulation. She also announced a GBP100 bn package in response to the energy price crisis, including a cap of GBP2,500 on households’ annual energy bills. This will aggravate the UK’s weak fiscal position and make the Bank of England even more hawkish. We are underweight sterling and gilts.

Despite some upbeat economic news last week, central banks maintain their hawkish resolve. The marginal improvement in the ISM purchasing managers index for services indicates that the US economy remains resilient. The same conclusion can be applied to the eurozone, where Q2 GDP grew 0.8% quarter on quarter. The European Commission is trying to hammer out a concrete plan to combat high energy prices, but this will be difficult to implement—and with the IG Metall trade union in Germany asking for an 8% wage rise, we are now seeing the second-round effects of the surge in consumer inflation. All of this supports central bank hawkishness, with the ECB delivering a 75bps hike last week, weakening the US dollar. While Fed vice chair Lael Brainard acknowledged the risks of overtightening, the Fed could decide a hike of of the same magnitude next week, notwithstanding some easing of supply constraints and increased labour participation. While Brainard noted a 0.1% deceleration in core inflation, we believe median inflation is a better indicator of the breadth of the inflation challenge. The continued strength of the Swiss franc shows the market anticipates the Swiss National Bank will follow the ECB’s lead by hiking by 75bps in two weeks’ time. Although the latest GDP figures were weak, Swiss inflation is well below European levels. We are overweight the Swiss franc and neutral Swiss equities.

The focus on rate tightening has been pushing up government bond yields, with short-term yields in Europe marking new highs last week. As Italian elections approach, we are negative euro area periphery bonds. On corporate earnings, analysts’ estimates for S&P 500 companies for Q3 and 2023 have declined by 5.5% and 3.7%, respectively, reflecting an adverse economic scenario. Global equity markets rose last week, benefiting from dollar weakening. But this means valuations have become less attractive. We are underweight global equities.