Economic Insights for July 2022: A Record Worth Checking against What Happened

The following were the economic insights for July 2022.  Headline inflation ticked up across most countries in May.  Central banks were aggressively raising key interest rates to bring it under control.  A strong market majority expected the Federal Reserve to raise rates by as much as 75 basis points at its next meeting, reaching neutral levels near 2.50 per cent by end-July, and possibly above neutral, near 3.75 per cent, by end-2023.

The European Central Bank hinted at a roughly 200 basis point increase in policy rates by year-end.  Broad monetary tightening, paired with tighter fiscal policy, was fuelling fears of recession within twelve to eighteen months.  The expectation at the time was that central banks would soften once rates reached restrictive territory, reducing the odds of a severe downturn.

China was Still the Outlier

China showed signs of improvement in June, with a strong pickup in services and construction as Covid restrictions eased.  China remained an outlier against a world of surging inflation, still able to pursue selective monetary and fiscal easing while everyone else tightened.

Asset allocation remained the largest driver of portfolio outcomes amid volatile markets.  Bond yields had risen sharply.  Most asset prices had fallen.  US Treasury yields sat at levels not seen in over a decade, and major funds had already dialled equities down to a small underweight, holding a moderate cash position as dry powder against a rising recession risk.

The expectation was for equities to weaken further as earnings forecasts fell under inflationary pressure, with valuations unlikely to expand during a slowdown.  A moderate overweight to Asia ex-Japan equities was recommended, driven primarily by China’s relatively positive trajectory, still trading at attractive valuations even after its recent rise.

Credit and Rates, as They Stood

Investment-grade credit spreads had widened meaningfully year to date, though modestly against their own historical range, given a gentle default and downgrade cycle.  Shorter duration was advised, positioning for further hawkish surprises from the Federal Reserve.  Asian credit was preferred over US credit, expected to hold up better despite a narrower spread premium.

The Federal Reserve’s pivot toward aggressive inflation fighting had already pushed bond yields up sharply.  Short rates moved faster than long rates, flattening the yield curve materially even while near-term fundamentals stayed robust.  Higher rates, more volatility, and weaker bond price performance were expected to continue over the medium horizon.

The Federal Reserve did not stop at 75 basis points once.  It delivered four consecutive 75 basis point hikes through 2022, pushing the federal funds rate past 4 per cent by year-end, beyond the 3.75 per cent ceiling this report anticipated for 2023.  The flattening yield curve this report flagged went on to invert fully, a signal that preceded banking stress the following spring, including the March 2023 collapse of Silicon Valley Bank.  China’s outlier position did not hold either.  Its own property crisis deepened through 2023 and 2024, eventually requiring the stimulus measures this report never anticipated needing.  The Asia ex-Japan overweight call aged reasonably well over the following two years, though not without volatility along the way.  A forecast this detailed, checked four years later, is a useful reminder that every position in this document was a probability, not a certainty, and the ones that held up best were the ones built on structural reasoning rather than a single quarter’s data point.

---

Terence Nunis | Executive Chairman, Equinox Zenith | Author, The 1% Playbook: The Billionaire Cheat Code