Exposure rates of the Dorval Asset Management Range – 11th February 2022
With the Fed now relying on economic data, observers expect a swift series of rate hikes over the months ahead. The implied Fed Funds level in the market comes to 1.75% at the end of the year, equating to a 25-bps rate hike at each of the seven forthcoming FOMC meetings. A 50-bps hike at the March 16 meeting has been mentioned by some of the Fed’s voting members and is already even partly priced in.
Gradual spread of inflationary pressure
_Goods (excl. energy and food) / Services (excl. energy)
Energy (LHS) / Food (RHS)_
The fixed income market is thus already pricing in much swifter monetary policy tightening than in the 2015-2018 cycle, yet in these circumstances, should we not be concerned about a swift slowdown in growth or even a recession? The hasty flattening of the yield curve seems to be pointing in this direction (cf. chart 2).
The mysterious message from long-term rates
We feel that it is premature to draw this conclusion. Growth in the US and Europe in the first quarter looks set to be lackluster as a result of the Omicron wave and disruption from the shock on prices this winter. However, most epidemic scenarios point to a decrease in infections with the worst affected sectors reopening fairly quickly from the Spring, particularly in the services sector i.e. tourism, hotels, dining, shows, leisure, etc.
The relative performance between cyclical and defensive stocks suggests that equity investors remain confident on growth (cf. chart 3): otherwise, how could we justify the performance from sectors that are so exposed to the economic outlook, such as banks for example. So the scenario of a valuation “reset” actually seems to have been playing out since the start of the year.
No message on the growth outlook from the markets
However, the central banks’ aim to tighten financial conditions is dragging down market sentiment. Uncertainty on the path for interest rates and the extent of this valuation “reset”, while partially complete, is a source of unease and we therefore maintain moderate risk allocation in our international portfolios.