Fiscal Policy Has Responded To Energy Costs In Some Countries, Especially In Europe
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Policy remains a headwind
The improved mood of investors can be linked to hopes for a less restrictive path for monetary policy — if not now, then later in the year. However, it seems that central bankers in the developed world remain more concerned about the risks of letting inflation expectations become embedded in the behavior of businesses and consumers than anything else. They have repeated this mantra is recent weeks, even as they recognize that the accumulated tightening across the major developed economies appears to be starting to have some impact. The US Federal Reserve (Fed) slowed the pace of rate hikes to a more normal cadence at its early February meeting and talked optimistically of Exhibit 2: European Natural Gas Front Month Futures Contract As of January 31, 2023 Index 350 300 250 200 150 100 50 0 Jul21 OctSources: Bloomberg, 21 Jan Macrobond22 Apr22 Jul22 Oct22 . Important data provider notices and terms available at www.franklintempletondatasources.com a disinflationary process that is underway. The Fed indicated it was getting closer to the end of its tightening cycle but did not suggest that it viewed the cycle as “job done.” What the Fed did say was that the central bank would be highly data dependent in executing its monetary policy objectives.
This contrasts with the Bank of Japan (BoJ), which is still at the start of this process and yet to make a first move toward more normal interest rates. Still, the Fed’s message resonated with comments from the Bank of England (BoE) as that central bank hinted at an imminent pause to rate hikes. And even the European Central Bank (ECB) sounded more circumspect even as it and the BoE continued to hike at a relatively rapid pace. The ECB resisted the temptation to give strong forward guidance beyond stating that it would make decisions on a meeting Jan23 bymeeting basis. This was viewed initially as supporting the idea that a peak in rates was approaching. However, we think the more accurate observation is that the lack of guidance, and increased data dependence, will leave financial markets more vulnerable to changes in the interpretation of the economic outlook. It also reinforces our view that policymakers remain laser focused on inflation.
Taken together with the prospects for a continued slimming of central bank balance sheets, expected central bank hikes will moderate negative real rates and sustain restrictive conditions
Although fiscal policy has responded to energy costs in some countries, especially in Europe, it will be slow to sway dovish in others, leaving it more differentiated across economies. However, the ongoing tilt in global policy is still quite hawkish. Overall, this sees our final theme complete a set of three still quite negative drivers for markets, even as it evolves to downplay the pace of hikes while emphasizing “Policy to Remain Restrictive” move through 2023. as we
Equity valuations had moderated (the multiples of earnings at which stocks trade fell considerably), but the levels of anticipated earnings per share have yet to decline meaningfully. The more recent improvement in sentiment and recovery in stock prices appear to underplay ongoing concerns around economic growth, inflation and likely policy responses. Investor sentiment may have got ahead of itself and supports us remaining moderately cautious in our view of stocks, rather than becoming bolder.
We entered 2023 with an allocation preference away from stocks, which we have retained in recent months, but over the next few quarters, we anticipate that a nimble investment management style will continue to be required. We are more attracted to the yields available in highquality government bonds, although they too may have discounted an overly sanguine view about an imminent end to the rateattractive longerhike cycle. Although we still see term return potential for stocks and believe they should earn their equity risk premium over time (see Exhibit 3), this premium is not high enough to reflect the uncertainties markets currently face or support an equity preference at this time, in our assessment.
Allocation settings views —February 2023
Source: Allocation views | Franklin Templeton
