Alastair George believes that at the mid-point of 2023 investors continue to walk a monetary tightrope. Fears of sticky, above-target inflation now alternate with growth concerns over the medium term. Markets are still assessing the ultimate impact of the long period of rising global interest rates and declining credit availability on corporate profits and valuations. Inflationary pressure remains a key risk factor for markets. The US Federal Reserve’s ‘hawkish pause’ this month kept rates on hold, but policymakers guided for a further rate increase in July. The US Fed is therefore talking tough while waiting to assess the impact of a 5% move in US rates. In the eurozone, the ECB is turning attention to the contribution of corporate profits to inflation while the UK seems to be an unfortunate special case. Core inflation is still rising and the Bank of England has been forced to increase rates by a further 0.5% this month. We continue to believe the tightening of credit conditions in the US and rapidly declining credit growth in Europe portends a slowdown in economic activity. For now, the services sector of the economy appears to be in robust health, but surveys and commodity prices suggest fading demand in the manufacturing sector. The spread between German two- and ten-year bond yields is now as inverted as at any time since the early 1990s, suggesting bond investors believe recession risks lie ahead. We maintain a neutral outlook on global equities but believe US long-term government bonds are increasingly attractive. With factory gate inflation having slowed sharply, we now expect government bonds to outperform as growth decelerates towards the end of the year. However, global equity valuations slightly above their long-term averages offer little directional guidance at a time of cyclically low earnings growth.
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