The last ten days will go down in central bank history as one of the biggest shifts in monetary policy ever. Surprisingly, the market has been off of central bank menus in past years, but now it is the dish of the day.
First, the US Federal Reserve came in with a monster hike, then the European Central Bank switched gears, the Bank of England pulled through, and the Swiss National Bank caught markets off guard (see ‘number of the week’). Ironically, this comes at a time when media coverage on inflation is at its highest, even though inflation gauges show signs of rolling over. Growth on its own looks far from stellar for the second half of the year. Given that central banks can hardly control the next six months in terms of economic impact, the U-turn seems to be aimed at the gallery. In other words, central banks are ‘as hawkish as it gets’, which implies that they may want to change course soon by softening the tone over the summer.
The turnaround was good enough to throw sentiment out of the window. The latest investor surveys have been showing that confidence is shattered – and for good reasons, as the liquidity impact has been devastating. Thus, our fixed income colleagues highlight that the risk-reward ratio in corporate bonds is solid, unless you are considering selling them anytime soon. The same holds true for equities where liquidity was sucked out of the market, leaving only losers. Given the breadth of the sell-off, markets are approaching buying territory, which resonates with the infamous ‘mid-summer rally’ in stock-market folklore.
Conclusion for investors
This is a tricky one, of course, as history reminds us that the liquidity drain could derail the economy. For a recession case, our models suggest a 10%–15% downside in stocks from here. So the safer bet is to wait for some stabilisation before going on a bottom-fishing spree in the near term. On a single stock level, there are opportunities emerging, which offers operational excellence combined with undemanding valuations.
Number of the week