No Pain, No Gain

Highlights:

• A false sense of calm dominates global markets as the curtain falls on 1H23, as the US economy defies gloomy expectations and financial volatilities across Equity, Credit and FX fall to suspiciously low levels. Increasingly global markets look priced for Goldilocks: no recession this year, a strong rebound in earnings over the coming 18 months and a quick normalisation of inflation.
• AI, falling commodity prices and the normalisation of the supply chain support such benign scenario. But we do not think central banks will win the battle against inflation without a larger retrenchment in labour markets and final demand. Cracks in the credit space are widening: our economic forecasts are below consensus.
• Mind what you wish for: persistent pricing power in a new inflation regime would support further margin expansion and earnings, yet would inevitably lead to much higher terminal rates, and eventually a boom-and-bust scenario.
• We see outright value in elevated long-term US real yields, and relative value US inflation breakeven vs. EUR. Bond yields are skewed to the downside, if not much. We reduce our OW in IG and stay UW in HY credit. We reweigh Govies, and quasi even more as they should benefit from a narrowing in swap spreads. Volatilities are set to rise, except in Rates. We stay defensive towards equities, both in terms of allocation and factor.
   

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