Transcription

• Disclaimer

  This podcast is only for the attention of professional investors in the financial industry. Outerblue by Amundi. Welcome to Outerblue Convictions,, Market Analysis and Asset Allocation Views.

• Silvia Di Silvio

  Hello and welcome to Amundi's monthly discussion on our latest analysis of markets, asset allocation trends and investment convictions. I'm Silvia Di Silvio, Senior Cross-Asset Macro Strategist at the Amundi Investment Institute, and I'm joined by Monica Defend, Head of the Amundi Investment Institute. Monica, welcome to our monthly podcast.

• Monica Defend

  Thank you, Silvia. So glad to be with you today.

• Silvia Di Silvio

  This month, we cannot refrain from talking about the war in Iran. The conflict that burst on 28th of February is shaking global markets and posing risks to the global economy. As we are experiencing a surge in energy prices, with Brent up by more than 50%, alongside a sharp rise in European natural gas, inflation is at the forefront of markets' concerns. Monica, the war in the Middle East has made the outlook significantly more uncertain. The news flow around the evolution of the conflict is very intense and actually, just a little before we started recording this podcast, which is on Monday afternoon, Trump announced on social media that after conversations with Iran, he decided to postpone strikes on Iran energy sites for five days. But shortly after, some Iran sources denied being in contact with the President of the United States. So, Monica, while we continue to process all of these developments, let's start our conversation from inflation, which is at the epicenter of markets concerns. How do you see this sudden and abrupt surge in energy affecting prices?

• Monica Defend

  Well, as you said, the headlines are really kinetic and the uncertainty is just so high, by itself volatile, which is really very, very difficult for us to ground analysis on firm assumptions, if not staying on the scenario analysis. But to answer your question, this is clearly a staginflationary impulse, but the key issue in our mind is not really the first round effect, so the effect on headline inflation, but how these will propagate. In the near term, higher energy prices lift headline inflation almost mechanically, I would say, and at the same time we can see growth by compressing real incomes and margins. And I will say that market so far has been very worried about inflation overshoot, less on growth. It's only recently that we are seeing some high pricing on growth uncertainty. Europe is particularly exposed, given its dependence on imported energy, while the US at this stage is relatively more insulated. So for now, our base case remains that this is a temporary shock, hopefully so, and a relative price adjustment rather than a structural inflation regime shift. So we expect a spike in headline inflation peaking in the coming months and then gradual normalization. However, if the shock persists, the dynamics will be changing and this is what we are currently analyzing. Energy in fact would feed into transport, fertilizer, food and broader industrial costs and that creates the so-called second round effects through wages, margins and inflation expectations and that's where inflation becomes more persistent and more difficult for central banks to manage. So the distinction is critical. Short-lived shock, manageable inflation, vis-à-vis persistent shock, embedded inflation. So when investors will reprice inflation expectations at higher level, this would be the trigger. So for now it is an energy shock with staginflationary features. It becomes a broader inflation problem only if persistency creates second round effects.

• Silvia Di Silvio

  I see, thank you Monica. So as you said, for now our base case scenario remains one of a relatively short-lived spike in energy prices, but given the extremely poor visibility on the duration of the conflict, how would our analysis change? Was the shock going to become more persistent than expected?

• Monica Defend

  Yeah, you know, the base case is itself temporary. This is what we are currently discussing. And again, given the kinetic headlines, it's really difficult to take a firm window of assumption. So the persistence case is qualitatively different. It is the bridge from inflation shock to broader macro dislocation. So if the shock persists, we are no longer in a simple energy story, as we were saying, we are in a broader macro dislocation. The first step will be the second round effects, higher energy costs feeding into transport, food and industrial inputs. Firms will protect their corporate margins, wages will likely adjust and inflation expectations will begin to drift. The second step, though, it relates to growth. Real incomes will be squeezed, consumption will weaken, and investment will be delayed. So the growth impact becomes more pronounced over time. There is also an important structural dimension. The Gulf is central not just for oil and gas, but also for fertilizers, as we are hearing. So a prolonged disruption can actually affect agricultural output and food prices globally. In that environment, we would clearly revise inflation higher and more persistent, growth lower, and markets more volatile. So the bottom line, my takeaway is that persistence changes the nature of the shock from temporary inflation spike to sustained macro pressure. And persistence is the real regime changer. You know, we've been talking a lot about these regime shifts because it would turn a temporary spike into a wider macro and policy shock.

• Silvia Di Silvio

  Thank you, Monica. At this juncture, central banks are facing an even tougher job than usual, having to manage on one hand the inflationary effects of higher energy prices and at the same time the downside risks for economic growth. Last week we've had several central banks meetings. What is our take on their stance and what are we expecting going forward?

• Monica Defend

  Well, the short answer is easing is postponed, not fully ruled out. But if persistence rises and expectations drift, the next move can shift from delayed cuts to renewed hikes. And this is how this morning we wake up at the time of recording this podcast, Monday the 23rd of May. The market was pricing three hikes out of the ECB and one hike out of the Fed. So this is probably the most complex environment for central banks. They are facing, you know, the classic trade-off, higher inflation due to energy, but weaker growth due to the same shock. And importantly, this is a supply shock, not demand driven. The first step is likely to be a pause, as we saw last week. Central banks are not reacting mechanically to higher headline inflation, but the second step is crucial. They are becoming more cautious, still data-dependent. The focus shifts to inflation expectations and wage dynamics, in particular in Europe. The ECB, in fact, is the most exposed because Europe suffers both the inflation shock and the growth slow down. The Fed is relatively more insulated, but it's not immune, especially if energy fits into services inflation. So the overall stance is oppose, become more and more data dependent and maintain an easing bias, but with a much higher bar for cuts. And if the shock persists, the risk is a shift toward a even more hawkish stance. So for now central banks are on hold, but I would say on a more hawkish hold.

• Silvia Di Silvio

  I see. Let's now talk about a very important asset, which is the US dollar. Its strength is back in focus these days. The dollar indeed has fared relatively well in the crisis, reflecting its traditional safe haven status. Is our long-held view that the dollar is under a secular weakening trend at risk?

• Monica Defend

  The US dollar is behaving as expected in a risk-off environment for this type of shock where cash in US dollar proved to be probably the only safe haven, but the signal isn't once. So it is true the US dollar is somehow strengthening, reflecting its safe haven role and global liquidity dominance, but the move, very interesting, is not extreme and that tells us that the markets still see this as a shock. and not yet a regime shift. So for a structural dollar strengthening, we would need a persistent inflation in the United States, forcing the Fed into a sustained tightening cycle, combined with weaker growth elsewhere. So the trigger to see a reversal in the trend is to see the Fed start hiking, which is not our base case. So the conclusion is that the dollar remains for this type of shock probably the best first responder, but it is only a partial hedge and does not invalidate the medium-term weakening trend. So the dollar is working tactically, but not enough to overturn what we believe is a secular story.

• Silvia Di Silvio

  Good. Thanks, Monica. And let's put together all we have said so far. Now let's turn to the investment consequences what are the implications for asset allocation and portfolio construction at this point. Well this financial environment is really challenging the traditional portfolio framework. We are moving into a world where inflation risk and growth risk coexist with equity and rates that are pricing two different dynamics on growth and inflation. And that means that correlations become less reliable, less stable, as we're already seeing with equities and bonds moving into the same direction like today. So the first implication, I would say diversification must be multilayered, not just the stock and bonds, but also commodities. inflation linked instruments and FX. Second point I would like to make is that selectivity becomes really critical. In equities, price in power and real asset exposure matter much more than broad beta. Third, we need to be more tactical. Volatility is structurally higher, so positioning needs to be more dynamic. And finally, hedging becomes essential. But with realistic expectations, gold is more a diversifier in this context rather than a perfect hedge, and the US dollar is only a partial hedge. So my key takeaway is in a stagflationary world, resilience comes from smarter diversification, not from relying on a single protection. This is a world where layered diversification, not a single asset hedging matters. And we are not yet in a new regime, but the probability of moving into one new regime has clearly increased. Thank you, Monica. It's been a pleasure talking to you and thanks to all for tuning in. Come back next time for another conversation with Monica and check out our other podcasts at our Research Center.

• Disclaimer

  This podcast is only for the attention of professional investors as defined in Directive 2014-65-EU dated 15 May 2014 as amended from time to time on markets and financial instruments called MIFID II. Views are those of the author and not necessarily Amundi Asset Management SAS. They are subject to change and should not be relied upon as investment advice, as a security recommendation, or as an indication of trading for any Amundi products or any other security, fund units or services. Past performance is not a guarantee or indicative of future results.