Exposure rates of the Dorval Asset Management Range – 10th June 2022

Surging inflationary pressure is jeopardizing stabilization scenarios for the world stock-markets. The ECB has now also joined the Fed on the route to swifter monetary policy normalization, fueling investor fears on a fragmentation of financial conditions between countries of the north and south in the euro area.

The pace of rising oil prices is denting the financial markets, probably driven by expectations of a normalization in Chinese demand. Climbing oil prices driven up by rising demand are less hazardous in themselves than pressure from a drop in supply. However, this does cast some doubt over the idea of a peak in inflation previously held by some investors. Just like in some other economic sectors, very low oil stocks accentuate the response from prices to intensifying demand. However, we note that other commodities have not followed the uptrend taken by oil, making for a stark contrast with the start of the year (cf. chart 1).



Oil prices hit challenging figures, but this time metals are not following in their wake

Brent prices in USD (RHS) / LMEX metal prices index (LHS)


Looking beyond bad news on oil prices, core inflation pressure heightened again in the US in May. Stripping out food and energy, the price index was up 0.63% after a 0.57% rise in April and a 0.33% jump in March. In a more worrying development, the Cleveland Fed’s core inflation calculation (the so-called trimmed-mean CPI) has surged considerably after three months on a downtrend (cf. chart 2). This situation seems to challenge the idea of an easing on the inflation front, although it is still difficult to draw a clear conclusion on the basis of a month or two of data. The markets are now logically expecting three 50bps rate hikes from the Fed over the months ahead, which would set money-market rates at 2.3% by the end of the summer. 


Surge in core inflationary pressure in the US in May
% monthly change


It comes as no surprise that the ECB is walking the same path as the Fed with a few months’ lag. The European economy’s relative resilience in the face of sanctions and the recent development of inflationary pressure have prompted the ECB to make the fight against inflation its utmost priority. After a 25bps rate hike in July, it will probably up rates by 50bps in September, before rolling out other hikes to likely bring money-market rates close to 1% at the end of the year (cf. chart 3). The ECB’s normalization policy is based on admittedly downgraded but still reasonable growth projections, with a cruising speed of around 2% over the next two years, and unemployment stabilizing at a low clip. Meanwhile we note that the ECB’s model incorporates a scenario of an easing of the effects of the war in Ukraine from the end of the year. A risk scenario is assessed separately.


Markets now expecting money-market rates (ESTR) in the euro area to come to +1% at the end of the year

Expected European money-market rates give no cause for concern from an economic standpoint – they are set to remain well short of inflation – but the ECB’s policy is having a clear effect on bond market spreads. Risk premia on corporate bonds continue to rise, while spreads between countries in the north and south are widening considerably (cf. chart 4). This behavior is not entirely abnormal during periods of rising interest rates, as investors sell higher-risk bonds first. However the ECB is somewhat at odds as it has let it slip for several weeks that it intended to combat geographical fragmentation within the euro area. However, Christine Lagarde did not announce any new policy tools to tackle this issue at the bank’s press conference. The ECB probably hopes that credit spreads will ease again once German long-term yields stabilize. Additionally, geographical fragmentation for bank lending rates to economic agents may be less marked than for sovereign rates as a result of progress towards European banking union. This may be the correct analysis, but the fact remains that the ECB’s ambiguous communication on the subject can only fuel investor concerns.



Spreads widen considerably in the euro area

High yield credit spread “Itraxx Crossover” / 10-year yield spread between Italy and Germany


Against this bumpy backdrop, yield curves are flattening in Europe and the US, reflecting increasing anxiety on the sustainability of economic growth. Investors are worried that the central banks may be forced to hit the stop button on growth to achieve the required drop in inflation. In our portfolios this week, we have moderated the equity exposure rate in our flexible funds in response to rising oil prices and paltry US figures.




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