Falling inflation: watch out for oil!

Like the creatures of Lovecraft’s fantastic fortune teller, the monsters of the past resurfaced from forgotten depths at the beginning of the second decade of this millennium.

But war and pandemic don’t go together, it’s the inflationary hydra that worries investors and central bankers the most.

The American horror master revels in his novels by subjecting his characters to double trials, such as the protagonist. Dagon, a naval officer stranded on an unknown island with strange hieroglyphs, occasionally fighting the attacks of his addiction to ichthyoid titans and painkillers. For central banks, fighting the inflationary dragon will only be possible after a painful initial trial, similar to that of the ill-fated sailor: the forced separation of the morphine from the negative interest rates that flow too much through the markets’ veins.

Eighteen trillion dollars of negative-interest debt since November 2021, that financial antimatter, that turn-of-the-century anomaly, has vanished in the retaliatory fire of the 2022 bond crash.

Like Jerome Powell, who championed a 4.25% hike in key interest rates to reduce peak inflation that reached 9.1% across the Atlantic, Christine Lagarde finally knew how to shake off her predecessor’s legacy of patriotism. Take a money-saving path closer to Trishe’s.

In his December speech (probably the institution’s most iconic since 2013), he adorned himself with the same attributes that Mario Draghi displayed in his fight for the survival of the euro: unwavering determination and commitment… he now feels the sacred duty of kneeling completely before the demon of inflation.

It is too early to say whether the battle has been won, but a severe energy recession is fading as France exports electricity again with 75% availability of its nuclear reactors thanks to falling gas prices.

American bank Goldman Sachs is also revising its growth expectations for the euro zone (+0.6% vs. -0.1% previously), adding to the relative attractiveness of European stocks (offering an expected earnings yield of more than 8 for the next twelve months). versus just 5.7% in the US).

However, the slowdown in inflation should not make Christine Lagarde doubt her commitment.

Conversely, the prospect of a soft landing makes the European economy less vulnerable to rising rates.

This could be an opportunity to compensate for the delay received in 2022 by accelerating the rate (+50 basis points in February and March according to Goldman Sachs). Thus, the money room for maneuver would be rebuilt more quickly.

Moreover, the ECB operates with a 3-4 month lag effect. We still need a sustained decline of at least a quarter to register a decline in inflation!

It will not be easy to calibrate monetary and public policy to place Monetary Union in the ideal zone, a narrow target sandwiched between a “money” recession and an energy recession…

Especially since energy risk isn’t entirely ruled out in the short term: Oil looks surprisingly cheap given the strength of China’s reopening, the decline in US inventories and falling Russian supply.

Undoubtedly, stockpiling during a zero covid policy, uncertainties about global growth could justify prices below $80. But the blood money paid (the worst carnage since the Great Leapfrog killed 36 million people), the party’s now unconditional support for the recovery (monetary policy to support the private sector, the end of internet reform), support for the balance sheets of giants, real estate developers, and measures to benefit the housing sector and etc.

In fact, industrial metals can lead the way. Since last weekend, they have been pushing forward with mobility data and pro-growth party announcements. Year-to-date, aluminum, iron ore, and copper are up 7%, 8%, and 10%, respectively.

Above $1,900 an ounce, gold has weathered the jump in real rates at the start of the year and has been rallying since their decline thanks to encouraging inflation indicators on both sides of the Atlantic. In 2023, it may benefit from favorable conditions to play its protective role: capping or even withdrawal of real exchange rates, uncertainties about growth, weakening of the dollar as the rate hike program in the United States nears its end.

For investors looking for the yield that precious metal doesn’t offer, European investment-grade credit yields an average actuarial yield of 4% (highest since 2012), versus 7.5% for a BBB- or lower-rated deposit. As for the better-capitalized AT1 bonds offered by European banks since 2008, they pay a coupon equal to the stock market yield…

At the end of one of the best starts to the year in the history of European stocks, investors who want to prioritize prudence in their portfolios can discover the relevance of these profitable alternatives to the stock markets… And perhaps, an alternative hope to the sometimes terrifying world of 2022 that we are so used to…

Text completed on January 13, 2023 by Thomas Planell, Manager – Analyst.

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