Eurozone inflation soared in March, reaching an annual rate of 7.5%, its highest in decades. This was well above market forecasts and is surely a source of concern for the European Central Bank, which adopted a more aggressive tone at its last meeting.
Manufacturing PMIs dropped to 48.1 in March owing to the economic turmoil caused by the spread of the Omicron variant. This slowdown, which is likely to spill into April, reflects lacklustre new orders, rising commodity prices and ongoing supply chain disruptions.
US unemployment continued on its steady downward trend in March, dropping back to its pre-pandemic level of 3.6%. Alongside the solid job creation figures, there was also an impressive 5.6% rise in hourly wages. This will further fuel inflation and could prompt the US Federal Reserve to speed up its monetary policy tightening.
The war continues to be a source of uncertainty
The war in Ukraine is still the primary worry for investors and economic agents. The crisis could prolong the disruptions already handicapping supply chains and maintain the upward pressure on commodity prices – dampening any hopes of a swift return to normal inflation levels. It now looks like inflation will remain high for longer than expected in most countries, with a wage-price spiral possibly being triggered in places with tight labour markets. The United States is one such place – wages have been rising there for several quarters.
Persistent inflation has prompted central banks to start scaling back the emergency stimulus measures introduced at the start of the pandemic. The US Federal Reserve, for example, has already begun raising its policy rate – although it clearly waited too long to start tackling inflation, as consumer prices are climbing at their fastest pace in nearly 50 years.
The Fed and other central banks are leaving it up to governments to “do whatever it takes”. Some political leaders, particularly in Europe, will probably let their budget deficits expand in order to protect low-income households from higher fuel prices.
Europe is the region where the economy is the most under threat – especially if the war in Ukraine interrupts its supply of natural gas, which is essential to keeping the continent’s factories running. The US is located much further away from the conflict and should therefore be better able to withstand the geopolitical uncertainty.
We believe a conservative portfolio allocation is the most appropriate in the current climate. We have therefore shifted our equity weighting to neutral in recent weeks and are maintaining cash holdings so that we can seize opportunities as they arise – especially in the event of a military de-escalation between Russia and Ukraine.
In the meantime, alternative investments continue to provide effective protection against market swings. That’s also true for commodities, where we still suggest holding a diversified portfolio composed of industrial metals, gold and energy products. In addition, firm commodity prices could bolster the currencies of certain exporting countries.
We are bullish on the Australian dollar, which is offering above-average bond yields. Among the major currencies, the US dollar stands to be buoyed by the monetary tightening expected from the Fed in the coming months, while the Japanese yen could depreciate further due to the Bank of Japan’s wait-and-see approach.
Commodities – a new buy opportunity on oil
In a bid to raise his dismal approval ratings, US President Biden announced some sweeping measures aimed at tackling inflation. His main focus was rising fuel prices, which reached a record USD 4.20 per gallon – that’s about CHF 1.03 per litre (fuel taxes are much lower in the States than in Switzerland). The federal government will release one million barrels of oil per day from its strategic reserves over the next six months. The scale of these releases is unprecedented and will bring reserves down to 1984 levels.
This decision – partly taken in light of the mid-term elections in November – caused
oil prices to drop by more than 10% over the week. However, it had only a very limited impact on long-term contracts – those with delivery dates in December saw prices edge down only slightly. Market operators are very sceptical about the medium-term impact of this measure. There is currently a global production shortfall, and measures aimed at cutting oil prices will not spur producers to increase their output.
We share this view. Even though oil prices are up year on year, oil companies have still not ramped up production, exploration budgets have been cut, and the number of new wells is close to its 2020 low.
In addition, the sanctions against Russia will remain in place for some time, limiting the country’s capacity to invest in maintaining output. On top of that, open interest in crude oil futures – i.e. the total number of outstanding derivatives contracts that have not been settled – is at an all-time low owing to the sharp rise in margin requirements. Demand is strong and should quickly exceed its record highs, with the impact of COVID-19-related restrictions in China likely to be short-lived. We therefore think that the recent drop in prices is a buy opportunity, even though volatility will remain high in the short term.
Author
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Daniel Varela holds a degree in business administration with a specialisation in finance from the University of Geneva and began his career in 1989 as a fixed income manager. He joined Banque Piguet & Cie in 1999 as head of institutional asset management and with responsibility for bond analysis and management. In 2011, he became head of the investment strategy and Piguet Galland's investment department. In 2012, he joined Piguet Galland's Executive Committee as CIO.
