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Q3 Investment Outlook: The Great Reset

Surging inflation, hawkish central banks and the war in Ukraine have dominated global markets through the first half of 2022. In response, central banks have sought to strike a balance between reducing inflation by tightening financial conditions and mitigating the impact on economic growth. This quarter could prove a turning point in that approach.

Highlights

  • With inflation edging higher throughout the subsequent quarter, however, the question has become how hard the landing will be.
  • China is an outlier. It is navigating a different stage of its economic cycle from most other countries and pursuing a markedly different Covid strategy.
  • Many are already feeling the inflationary pinch, with cost-of-living crises and diminishing purchasing power providing major headwinds.
     

Originally published on July 7, 2022
Written by Andrew McCaffery, Global CIO, Asset Management


Inflationary pressures have intensified, and supply chains are being redrawn. Fidelity International sees this as the start of “the Great Reset”, in which the Federal Reserve (the Fed) leads central banks down a more hawkish path that prioritizes managing inflation above a soft landing. As a result, downside risks to global growth have increased exponentially. Given its greater exposure to the war in Ukraine and vulnerability to deteriorating gas flows from Russia, recession in Europe now looks very likely, while the U.S. too has edged closer to a hard-landing scenario.

Fidelity International’s latest quarterly outlook outlines the thoughts of its investment teams as they navigate these changing landscapes.

 

Three themes for Q3

Fidelity International’s Q3 Outlook highlights three key themes which Fidelity International expects to dominate this quarter.

1. Hard or crash landing

As recently as March, it seemed possible that central banks could engineer a soft landing by front-loading rate hikes and then readjusting mid-course. With inflation edging higher throughout the subsequent quarter, however, the question has become how hard the landing will be.

This pivot was marked by the Fed’s decision to match its hawkish rhetoric with hawkish action: a 75-basis-point rate hike in June could well be matched by a further 75-basis-point increase in July. The European Central Bank and the Bank of England are likely to pursue a shallower hiking path, due to their economies’ increased exposure to the Ukraine War and greater risk of recession. Nevertheless, the risks to global growth are clear. Fidelity International has increased the likelihood of a hard landing scenario, in which central banks push the economy into a recession (either accidentally or on purpose), from 35 per cent to 60 per cent.

2. China re-emerges from lockdown.

China is an outlier. Navigating a different stage of its economic cycle from most other countries, it’s also pursuing a markedly different COVID strategy. Its zero-COVID policy (ZCP) placed many major cities under severe lockdowns, most notably Beijing and Shanghai. These generated a short but sharp economic downturn through April and May.
China’s re-emergence from the spring lockdowns is a clear positive for its economy, but many indicators suggest caution is still warranted. Primary property sales are well below previous levels, while unemployment (particularly among youth) is rising, causing concern for a government that is focused on social stability. This is particularly important in the run-up to the 20th Party Congress.

Similarly, while China’s fiscal and monetary policy is increasingly supportive, its ultimate effectiveness and the nature of consumer sentiment post-lockdowns remain unknown. It’s also yet to be seen whether China’s economic recovery will be strong enough to offset slowdowns elsewhere in the world. That said, the likelihood of China decoupling from the rest of the world in the second half is gathering momentum.

3. The global consumer is put to the test.

The global consumer has a lot on their plate. Many are already feeling the inflationary pinch, with cost-of-living crises and diminishing purchasing power providing major headwinds. Real wages are falling, and mounting discontent is being reflected in record-low consumer confidence indicators across the globe.
In parts of the world, what consumers are doing is yet to reflect what they’re thinking. Though U.S. consumer sentiment has plunged in recent months, retail sales remain resilient, buoyed by stimulus-laden bank accounts. With mortgage rates rising and affordability metrics plummeting, it’s likely that low confidence will soon translate visibly into diminishing activity levels.

The Chinese consumer too faces headwinds, with ZCP restrictions still fresh in the mind and unemployment on the rise. Any further lockdowns would prove a further blow to consumption.

Ultimately, the resilience of the global consumer in the face of rising costs and tightening financial conditions could prove key in determining the severity of the economic landing.

This quarter may prove vital in determining the trajectory for markets and economies over the next few years. In this rapidly changing environment, Fidelity International’s focus is on managing risk coupled with mapping the medium-term implications of “the Great Reset” At the same time, periods of uncertainty create a raft of opportunities for individual companies across a range of sectors, some exposed to long-term trends that were previously overbought, others overlooked during the rush for growth.

 

Issued by Fidelity Investments Canada ULC (“FIC”). Unless otherwise stated, all views expressed are those of Fidelity International, which acts as a subadvisor in respect of certain FIC institutional investment products or mandates.

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