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Q2 Outlook: The “Grand Chessboard” reconfigured; stagflation risks intensify

Fidelity International's investment team sets out the three themes it expects to dominate the second quarter as the global order is redefined and stagflation risks intensify.



  • The timeline of the Ukraine war will influence economic outcomes
  • The return of Volckerism
  • Conditions support China outperformance, but this is not 2008
  • Key themes and their investment implications by asset class

Written by Andrew McCaffery, Global CIO, Asset Management
Originally published in April 2022


The Russia-Ukraine war is set to dramatically redefine the global order (or the “Grand Chessboard"1), both economically and geopolitically. In the near term, the trade and financial shocks from the conflict and associated sanctions are exacerbating global inflation pressures. 

The concurrent hit to growth and to overall confidence is likely to be meaningful, but its magnitude and duration are uncertain. Europe is the most exposed region, with at least a modest recession very likely. While the U.S. is relatively insulated for now, it is not immune either, particularly from the inflationary impacts of the war. 

Energy and resource interdependencies are already shifting in what is certain to be a multi-year global adjustment, with implications across numerous asset classes. 

Fidelity International’s investment team expects three themes to dominate this quarter.


1. The timeline of the Ukraine war will influence economic outcomes.

The war in Ukraine has already caused significant economic damage, and it will continue to shape the near-term outlook for global economies, particularly Europe. Outcomes over the coming quarter will be heavily influenced by the timeline to a resolution and the easing of trade disruptions. 

In the meantime, any hopes for a moderation in energy prices and supply chain disruptions have been dashed. Fidelity International’s investment team believes that together, these dynamics will continue to dampen growth and put upward pressure on already high inflation.

This paints an extremely complex picture, both for policy makers and the markets. Fidelity International’s investment team believes the market has yet to reflect the full range of possible outcomes, which span extreme left and right tail risks. They advocate nimbleness and the use of hedges, where appropriate. 

2. The return of Volckerism

A second major theme for markets for this coming quarter and year is the challenge faced by central banks in reining in inflation given the new geopolitical and economic 

backdrop. The three major developed market (DM) central banks have turned decisively to a hawkish narrative. In the U.S., the Federal Reserve (the Fed) has invoked the stance of former Fed Chair Paul Volcker, who tamed inflation in the 1980s, and initiated lift-off at the March 2022 FOMC meeting. While Fidelity International’s investment team expects the Fed to front-load hikes and the European Central Bank to continue its hawkish tone, they believe the war-induced growth shock and the need to maintain negative real rates will lead to dovish pivots by mid-year. 

All this could make for a challenging quarter for developed market risk assets. Fidelity International’s investment team advocates positioning for the high likelihood of stagflation in DMs, with a base case of recession in Europe. Careful engagement with risk assets at this stage is critical. 

3. Conditions support China’s outperformance, but this is not 2008.

China could serve as a useful diversifier. The region is further removed geographically and economically from the conflict, it benefits from capacity for further monetary and fiscal easing, and it offers more attractive starting valuations. 

At the same time, uncertainty remains high. China’s policy goals are focused on deleveraging, property sector reform and sustainable growth. In this regard, its outlook now appears less straightforward than it did in 2008 during the global financial crisis. Fidelity International’s investment team doesn’t expect China to repeat its previous role as the “fiscal put” that dislodges the global economy from its stagflationary trajectory.

Key themes and their investment implications by asset class

Solutions and multi-asset

Given the near-term uncertainty around global growth, Fidelity International’s investment team now has lower-than-benchmark positions in both credit and equities. They are particularly cautious on European equities and the euro, given the likelihood of recession in Europe.

Fidelity International’s investment team has a more positive outlook for emerging market equities, including China, and Asia Pacific stocks excluding Japan, as well as select emerging markets fixed income, given the diversification potential and possible support for commodity exporters. Finally, Fidelity International’s investment team are taking long U.S. dollar positions: they expect interest rate differentials to support the dollar as the Fed remains focused on inflation, and for its defensive characteristics to provide protection should conditions deteriorate. 


Fidelity International’s investment team believes that focusing 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. Equities should still provide a robust source of income, now that balance sheets have been repaired following the worst of the pandemic. 

Fidelity International’s investment team is cautious on Europe given the risk of recession there, but see the potential to diversify in some emerging markets, particularly areas that are benefiting from the commodity price surge. Parts of China look cheap, though volatility is very high and tail risks have grown fatter. 

Fixed income 

Stagflation presents a challenge, but there are some areas within fixed income that Fidelity International’s investment team thinks will be better protected from rising rates and slowing growth. Break-evens should continue to perform relatively well, on the premise that inflation expectations will rise, and the team is also constructive on euro investment grade (IG), given its more defensive characteristics and improved valuations. 

Fixed income investors should not fear duration. The upside for nominal yields will likely be capped by debt refinancing constraints, central bank actions and demand for safe havens. Fidelity International thinks European Central Bank (ECB) rate hikes are unlikely in 2022 (despite the ECB sticking to its hawkish tone in March), and so sees value in core European duration. Fidelity International is more cautious on China. The property market remains a concern and Fidelity International’s investment team expects further volatility ahead. 

Private markets

The direct impact of the war on Fidelity International portfolios has so far proven limited, with the markets’ resilience meaning there have been few dramatic pricing movements. Nevertheless, the wide-ranging and often indirect supply chain disruptions resulting from the war make this a period for careful active investing and credit selection. 

Private credit can prove an effective hedge against inflation due to the floating rate coupons. It also offers a senior position in the capital structure and high levels of income with low volatility. 

Fidelity International’s investment team’s focus now is on companies that can withstand further cashflow and margin pressure. 

Real estate

The main risk to real estate right now is slower economic growth. Fidelity International’s investment team believes markets have been slow to react to the crisis and as such are exercising caution. They are monitoring their existing tenant base for increased risk, and carefully scrutinizing any new tenants.

Stagflation is also a concern. Real estate typically fares well through short periods of inflation, but less well in prolonged periods of stagflation. Nevertheless, Fidelity International’s investment team is still focused on long-term macro themes – health care, residential buildings and data centres – while inflation-linked leases offer a form of inflation protection.


All in all, stagflation risks have intensified, with the war in Ukraine disrupting the global growth trajectory, particularly for Europe, and spill-over effects tied to the path and timeline of a resolution. The conflict has also exacerbated inflation pressures, creating even more challenges for policy makers. Fidelity International’s investment team has been reducing risk since the start of 2022 and focusing on regions, sectors and asset classes that provide protection and income in a highly uncertain environment of slowing growth and rising inflation.

Contact the team

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