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'Stagflation risks are intensifying'

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Stagflation risks are intensifying, according to Fidelity.

The trade and financial shocks from the Russia-Ukraine war, and associated sanctions, are exacerbating global inflation pressures, Fidelity International’s Andrew McCaffery said.

According to Fidelity’s global CIO, the concurrent hit to growth and to overall confidence is likely to be meaningful, but its magnitude and duration are still uncertain.


Predicting a modest recession for Europe, Mr McCaffery said the US is not immune either, particularly from the inflationary impacts of the war.

The expert identified three key themes which he expects to dominate in the second quarter of the year.

The first relates to timeline uncertainties, with Mr McCaffery highlighting that any hopes for near-term moderation in energy prices and supply-chain disruptions have already been dashed. This, he believes, translates to further downward pressure on growth and upward pressure on already high inflation.  

“Outcomes over the coming quarter will be heavily influenced by the timeline to a resolution and the easing of trade disruptions,” the CIO said.

“This paints an extremely complex picture, both for policymakers and the markets. We believe the market has yet to reflect the full range of possible outcomes, which span extreme left and right tail risks,” he continued.

According to Mr McCaffery, the second major theme for markets for this year is the challenge faced by central banks in reigning in inflation.

“While we expect the Fed to front load hikes and the ECB to continue its hawkish tone, we believe the war-induced growth shock and the need to maintain negative real rates will lead to dovish pivots by mid-year,” he said.

“All this could make for a challenging quarter for developed market risk assets and we believe careful engagement with risk assets at this stage is critical,” Mr McCaffery predicted.

The third and final key theme for the second quarter in 2022 is China’s probable outperformance.

While tipping that China could very well serve as a “useful diversifier” given its geographical and economical distance from the conflict, Mr McCaffery judged that uncertainty remains high.

“China policy goals are focused on deleveraging, property sector reform and sustainable growth.

“In this regard, its outlook now looks less straightforward than it did in 2008 during the Global Financial Crisis. We don’t expect China to repeat its previous role as the “fiscal put” that dislodges the global economy from its stagflationary trajectory,” he noted.

What does this mean for asset allocation within asset classes?

Mr McCaffery expressed confidence in emerging market equities, including China and Asia-Pacific stocks excluding Japan.

“We are particularly cautious on European equities and the euro, given the likelihood of recession in Europe,” he said.

The CIO also tipped that focussing on high quality companies, rather than sector selection, is the best approach given the rising geopolitical and stagflationary risks.

“Companies with pricing power and the ability to protect margins should perform relatively strongly in this environment,” he said.

Turning to fixed income, Mr McCaffery pinpointed areas within the asset class that he thinks will be better protected from rising rates and slowing growth.

“Breakevens have the potential to continue to perform relatively well, on the premise that inflation expectations will rise, and we are also constructive on Euro Investment Grade, given its more defensive characteristics and improved valuations,” he said.

In regards to private credit, Mr McCaffery believes it has the potential to prove an effective hedge against inflation due to the floating rate coupons.

“It may also offer a senior position in the capital structure and high levels of income with low volatility. Our focus now is on companies that can withstand broader cashflow and margin pressure,” he said.

All in all, he noted that stagflation risks have intensified, with the war in Ukraine disrupting the global growth trajectory, particularly for Europe, and spillover effects tied to the path and timeline of a resolution.

“We have been reducing risk since the start of 2022 and focusing on regions, sectors and asset classes that have the potential to provide protection and income in a highly uncertain environment of slowing growth and rising inflation”.

'Stagflation risks are intensifying'

Stagflation risks are intensifying, according to Fidelity.

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Maja Garaca Djurdjevic

Maja Garaca Djurdjevic

Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.

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