Like the creatures of Lovecraft’s fantasy bestiary, the monsters of the past rose from the forgotten depths at the beginning of the second decade of this millennium.
But more than war and pandemic combined, it was the hydra of inflation that tormented investors and central bankers with the greatest distress.
In his novels, the American master of fright amuses himself by subjecting his characters to a double ordeal, such as the main character of Dagon, a naval officer stranded on an unknown island with strange hieroglyphics, struggling both against the assaults of an ichthyoid titan and those of his addiction to painkillers. For central banks, tackling the inflation dragon will only have been possible after a painful initiation test similar to that of the unfortunate sailor: the forced weaning of the morphine of negative interest rates that has flowed too much in the veins of the markets.
Since November 2021, eighteen trillion dollars of negative interest rate debt, that financial antimatter, that anomaly from the beginning of the century, has disappeared, consumed by the vengeful fire of the 2022 bond crash.
Like Jerome Powell, who is brandishing the idea of a 4.25% rise in key rates to slash the inflation peak that has reached 9.1% across the Atlantic, Christine Lagarde has finally managed to free herself from the accommodating legacy of her predecessor and take the path of monetary austerity, closer to that of Trichet.
In her December speech (probably the institution’s most emblematic since 2013), she adorned herself with the same attributes that Mario Draghi displayed in his fight for the survival of the euro: determination and commitment in every way… which she now dedicates entirely to the sacrosanct task of making the inflation demon bend the knee.
It is still too early to say that the battle has been won, but with the fall in gas prices, at a time when France, with 75% of its nuclear reactors available, is once again exporting electricity, the fear of a violent energy recession is fading.
Moreover, the US bank Goldman Sachs is revising its growth expectations for the euro zone (+0.6% compared with -0.1% previously), adding to the relative attractiveness of European equities (which offer an expected earnings yield for the next twelve months of more than 8% compared with only 5.7% in the US).
The slowdown in inflation should not make Christine Lagarde doubt her commitment.
On the contrary, the prospect of a soft landing[2] makes the European economy less vulnerable to rising interest rates.
This could be an opportunity to make up for the delay in 2022 by accelerating the pace (+50 basis points in February and March according to Goldman Sachs). The monetary leeway would thus be reconstituted more quickly.
Moreover, the ECB is working with a 3-4 month lag effect. At least one more quarter of continuous decline in inflation is needed to confirm its decline!
It will not be easy to calibrate monetary and state policies to land the monetary union in the ideal zone, a narrow target wedged somewhere between the “monetary” recession and the energy recession…
All the more so as in the short term, the energy risk has not been totally ruled out: oil seems surprisingly cheap given the strength of the reopening of China, reduced stocks in the US and the fall in Russian supply.
Admittedly, the accumulation of stocks during the zero covid policy and the uncertainties regarding global growth may justify prices below $80. But, because of the blood price paid (the most violent slaughter since the 36 million deaths of the Great Leap Forward), the party’s now unconditional support for the recovery (monetary policy in support of the private sector, end of the reform of the internet giants, support for the balance sheet of real estate developers and measures in favour of the residential sector, etc.) should get the better of oil inventories.
Moreover, industrial metals may be leading the way. They have been rising with the mobility data and the party’s pro-growth announcements since last weekend. Aluminium, iron ore and copper are up 7%, 8% and 10% respectively since the beginning of the year.
Gold, back above $1900 an ounce, withstood the rebound in real rates at the beginning of the year and has prospered since their decline, on the back of encouraging inflation figures on both sides of the Atlantic. In 2023, it could benefit from favourable conditions to play its protective role: a levelling off or even a withdrawal of real rates, uncertainties surrounding growth, and a fall in the dollar as the rate hike programme in the United States approaches its end.
For investors looking for a return not offered by the precious metal, European investment grade[1] credit offers an average yield of 4% (the highest since 2012) compared to 7.5% for the BBB- or lower rated deposit. As for the AT1 bonds offered by European banks, which are much better capitalised than in 2008, they pay a coupon equivalent to the profitability of the equity[3] market…
At the end of one of the best start of the year in the history of European equities, investors who wish to favour prudence within their portfolio could discover the relevance of these remunerative alternatives to the equity markets… And perhaps also, the hope of an alternative to the sometimes monstrous world to which 2022 has unfortunately accustomed us too much…
Thomas Planell, Portfolio manager – analyst at DNCA. This article was finalised in January 13th, 2023.
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