Outlook on the economy
Rising interest rates in the US
The combination of strong economic growth, a tight labour market and fast rising inflation in the US has made it abundantly clear: the US central bank (the Fed) will need to hike its interest rate. How fast and by how much the Fed will do so still remains to be seen. The market’s expectations changed last quarter. Analysts are now factoring in faster increases in 7 or 8 interest rate moves. This would bring the US base rate (currently 0.5%) to around 2.5% by the end of this year.
What is the ECB doing?
Compared with the Fed, the ECB (European Central Bank) has a more complex situation to deal with. While inflation in Europe is at least as high as in the US, it is much more driven by high energy prices. Europe is less self-sufficient in terms of energy and therefore suffered a harder blow. Another problem is that inflation rates vary widely within the eurozone: from 5% in France to well above 10% in the Netherlands. The market believes that the ECB will hike its rate twice this year, which would bring the European interest rate to 0% for the first time since 2014. However, the uncertainty about these interest rate moves is greater than in the US. This has to do with the major differences between euro countries as well as the uncertainty as to how the war will progress and how it will impact the European economy.
Stagflation: a risk for Europe
The entire European economy is also exposed to the threat of a stagflation scenario: a combination of economic slowdown and high inflation. The higher energy prices are weighing down on producer and consumer confidence, even though producer confidence indicators remained fairly stable in March. Hopefully the war in Ukraine will not spread any further. A recession still seems to be out of the question for now.
Instability and uncertainty
The risk of a protracted war, higher energy prices and tougher sanctions against Russia seems real. In addition, China’s COVID policy and possible rate hikes in the US could create instability. All this means the investment outlook is not all that positive. Our view on equities and corporate bonds remains neutral. In view of rising inflation levels and an increased likelihood of faster rate hikes, we maintain an above-average cash position (money that is not invested) and an underweight in government bonds. This underweight is more restrained than in the previous quarter as interest rates have already risen considerably in recent months.