The conflict in Ukraine, whose duration, risks of extension and exit scenarios are impossible to predict, is the backdrop for the current regime change in the markets with the word "stagflation1" summarising the macroeconomic content. Higher inflation and increased risks of stagnation are the two polarities, two sides of the same coin, and the conflict is the accelerator.
In recent weeks, the markets have moved rapidly from classic risk aversion, marked by a sharp fall in equities and a strong performance of safe havens - very similar to past corrections fuelled by recessionary fears - to phases more comparable to those at the beginning of the year, with equity rotation, volatility and a rise in long term rates.
In the face of uncertainty, there is a strong temptation to cling to the branches of the past. Comparisons with the oil shocks of 1973, 1979 and 1990 abound, as have the many arguments that the world has changed since then. However, several lessons remain valid. First, the idea that rising energy prices almost always lead to a slowdown in growth. Secondly, that central banks are caught between two fires, the risk of a slowdown and rising inflation.
In this volatile and changing context, the position to adopt by investors remains complex, and probably implies looking beyond the conflict, to apprehend the impacts in terms of growth, inflation, monetary policy and the evolution of corporate results.
In this respect, there is no doubt that this economic shock will primarily affect Europe, which is facing a sharper decline in growth than the United States and is more exposed to the risk of energy shortages. The other reason to be more cautious about Europe is that wages are growing at a slower pace than inflation, which will logically translate into lower consumption.
This is reflected in the correction in European equities, which de facto incorporates a slowdown in the economic recovery of the Euro Area and doubts on profit growth.
However, it would be illusory to think that the US economy will remain immune to this shock if the rise in energy prices were to persist. Here again, the judge will be the Federal Reserve (Fed), which will have to be flexible if US consumption also weakens. Some warning signs are already there, such as the recent fall in consumer confidence indicators, even though the strength of employment, wages and investment suggest that the US economy will remain in growth mode. This in turn is what makes the Fed confident that the US economy and financial markets can withstand this monetary normalisation.
1- Stagflation: Stagflation refers to an economy that is experiencing simultaneously an increase in inflation and stagnation of economic output.
Monthly House View, 22/03/2022 release - Excerpt of the Editorial
March 25, 2022