•In the eurozone, the increase in wholesale energy prices likely will continue to filter through to consumers. Surging input costs will put pressure on corporate margins, leaving companies little choice but to pass higher prices on to consumers. Alongside a weaker euro, these factors will drive the rise in inflation in the coming months.
•US real yields have reverted to levels where investors can expect some stability as hawkish central banks act to ensure inflation expectations remain steady. The key question is whether inflation will moderate, allowing the US Federal Reserve to drop its tightening stance before more cracks emerge in global markets. We believe such a pivot could at the earliest come once policy rates hit 4.75%-5.00%.
•Comments from hawks at the European Central Bank (ECB) hawks point to the intention to take policy rates to restrictive levels, with rising inflation providing a window of opportunity. The ECB is also increasingly likely to tighten policy through balance sheet reduction. As the ECB continues to withdraw liquidity from the market, investors may become increasingly concerned about Italy’s fiscal sustainability.
•Do current eurozone spreads reflect a further slowdown? We believe that they do. However, many of the more negative scenarios have in fact been realised. Also, credit metrics for eurozone investment-grade (IG) bonds are solid. The deterioration in the outlook for US corporates is likely yet to come, leaving us neutral on US credit and defensively positioned.
•The underperformance of hard currency emerging market debt means that spreads are now near peak post-GFC levels. We see high-yield, frontier, and selected IG country spreads as appealing. Within corporates, we see Latin America IG and Asian high-yield as the most compelling. On EM currencies, we expect a rebound. We see value in CEEMEA[1] and certain Asian currencies.
References
[1] Central and Eastern Europe, Middle East and Africa
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