Raiffeisen RESEARCH: Outlook - Impact of inflation

Gunter Deuber (Head of Raiffeisen Research), RBI Chief Analyst Peter Brezinschek and Christian Hinterwallner (Head of Equity Research) gave an outlook in an online press briefing today on how inflation will determine monetary policy as well as developments on the capital markets, especially the equity markets, this year.

Fed clearly focused on fighting inflation; ECB more hesitant so far

The Omicron variant, further possible COVID19 mutations, their knock-on effects and the considerable price pressure that will accompany them will determine the economic framework conditions for the financial markets in the third pandemic year. In sum, economic policy trade-offs become more complex. "In the U.S. and in EU countries outside the euro area, we already see a welcome central bank focus on fighting inflation," said Gunter Deuber. "At the Fed, we currently see such a clear focus in this regard that it seems to us very likely that this will even be accompanied by a tolerance for temporary (equity) market setbacks." The European Central Bank (ECB) has been much more hesitant so far, but 2022 is likely to become a "decision year" for them as well. "Given the economic conditions we expect, a complete decoupling of monetary policy in the euro area from that in the U.S. - as in the last decade - would not be opportune," said Deuber.

For financial markets and central banks, inflation risks are increasingly becoming the defining (long-term) issue.

After inflation averaging above 5 per cent in 2021, the Fed forecasts that inflation will gradually approach the central bank target of 2 per cent in 2022 (+2.6 per cent) and 2023 (+2.3 per cent) through 2024 (+2.1 per cent), but from above. This outlook of four (!) yearsabove the inflation target prompts the Fed to act. "Fed Chairman Powell's communication is clear: elevated inflation is a threat to the goal of full employment. Thus, the monetary policy course for 2022 is currently set for rapid normalization. We see potential for four interest rate steps this year," said Peter Brezinschek.

In contrast to the Fed, the ECB has so far communicated its monetary policy stance for 2022. It continues to see below-average rates of price increases in the euro area as a whole over the medium to longer term. Although its HICP (Harmonized Index of Consumer Prices) forecast revision from 1.7 to 3.2 per cent for 2022 in December was a first sensation, it is still not enough for a rapid exit from the very expansive monetary policy. This is because the inflation projections for 2023 and 2024 are still a touch below the 2 per cent target at 1.8 percent each.

However, the ECB's Governing Council is decidedly broad in its range of opinions, and the Raiffeisen analysts think that the ECB will not be able to afford such a pronounced divergence in monetary policy from the Fed as it has in the last decade. "For the first time in a long time, we see moderate key rate hikes in sight at the ECB, that is, within a normal forecast horizon of 12 to 18 months rather than years," Brezinschek said. "In sum, from a monetary policy perspective, we could be in for an interesting second half of 2022 for the financial markets."

Environment for investments becomes more complicated

On the bond market, the specialists at Raiffeisen Research see a rather difficult year in 2022, which is currently already evident from considerable new issue premiums for longer maturities. "With inflation remaining high, investments in non-euro EU countries will thus also be interesting in the fixed-income segment," said Deuber. "Here, central banks have raised key interest rates drastically in 2021 and 2022 in some cases, given domestic inflation risks and the Fed's discernibly more aggressive stance." In the European corporate bond markets, the analysts see the yield spreads to benchmark rates as so narrow that little performance can be expected over the year. Therefore, they recommend looking at short-dated bonds from non-euro EU countries as an inflation hedge.

2022 should be another good year for equities - inflation eats into earnings

"Despite more challenges of a macroeconomic nature, stock market investments will remain without alternative in 2022," said Christian Hinterwallner. "Therefore, overall, we expect another good year for equities in 2022. However, the risks for notable setbacks are increasing, especially in the second half of the year." With a weakening upward trend and continued high inflation rates, Hinterwallner therefore tends to expect only price gains roughly in line with corporate earnings growth. With less upward momentum, the focus on individual markets and investment styles would become more important. "We also expect another good year for the Austrian stock market in 2022 due to its clear sector focus and comparatively low valuation," Hinterwallner said. Nevertheless, the analysts see many reasons why European stock markets will not be able to outperform their US counterparts in the long term. The latter shine in particular with higher profitability and, thanks to their business models shaped by new economy and platform economy, can benefit sustainably from the changes in consumer behavior brought about by the pandemic.

The first interest rate hikes have now been well digested on the bond and equity markets, said Gunter Deuber. "However, if the U.S. Federal Reserve were to act in 2022 with four interest rate hikes plus further significant monetary tightening, then a difficult time will be upon us in 2023 at the latest - i.e. about one year after the first U.S. interest rate hikes. Due to some late-cycle phenomena on the financial market, for example in the area of valuations, we could then see significant setbacks," concluded Deuber.

Monetary policy outlook, accessible without registration:

Wide Angle Shot: Monetary policy on "new" conventional paths in 2022/23? (raiffeisenresearch.com)