Macro Monthly Answering three more key questions for the rest of 2022

Yes. Global policymakers are increasingly wary of the financial stability effects of the sharp rise in yields. The risks to government bonds are becoming more balanced.

In the UK, government bond yields jumped higher after a larger-than-anticipated fiscal package in the UK, and sparked a self-reinforcing spiral of domestic debt selling by pension funds. The Bank of England (BoE) made an about-face from imminent asset sales to net purchases of government bonds to put a floor under the gilt market and protect pension funds from potentially crippling losses.

In China, Japan, the European Union, South Korea, and India (among others), the central bank or fiscal authorities are intervening in foreign exchange or bond markets (or have prepared tools to do so). Central banks are prepared to push back against price action judged to be excessive or counterproductive to their goals.

Exhibit 1: US Bond volatility, yields ease off peaks after BoE bond purchase announcement

Source: UBS-AM, Bloomberg, data as at 3 October 2022

Yes. History shows that the US dollar is expensive on a valuation basis, but also that this condition does not prevent major overshoots.

Federal Reserve policy will continue to buoy the US dollar, in our view, as tightening will likely continue without a pivot to easing until material evidence of labor market weakness emerges or inflation returns much closer to target. Neither of those outcomes is probable in the near term. Central bank tightening will cause a series of dominos to fall across the global economy, and the US labor market is likely to be the last to topple. Globally, the goods sector will come under more stress, and has ample room for continued retrenchment as the share of spending continues to rotate towards services. The US is in a relatively better position to withstand headwinds because a lower share of GDP is linked to goods, Europe is more exposed to the energy price shock, other housing markets are more sensitive to interest rate movements (the 30-year fixed rate mortgage is the dominant US product) and China has been unwilling to durably reopen economic activity.

Exhibit 2: Market embracing “higher for longer” Fed stance

Policy rate expectations are higher across the curve versus mid-July.

Source: UBS-AM, Bloomberg, data as at 3 October 2022

Not enough of the positive catalysts from outside the US that could spark a reversal – an enduring reopening in China, a ceasefire between Russia and Ukraine, and the Bank of Japan ending yield curve control – appear likely to play out before year end. In particular, we believe the end of China’s zero-COVID-19 policy will be more of a process than an event, and one that plays out throughout 2023.

John Connally, the Treasury Secretary to Richard Nixon, famously told his international counterparts that the US dollar is “our currency, but it’s your problem.” In the near term, we believe that US dollar strength is likely to persist until it is too big of a problem for the US economy to bear.

Increasingly negative. July through September 2022 is the first period since Q2 2020 in which both revenue and earnings expectations have been revised to the downside over the course of the quarter. This is symptomatic of a decisive turn to a much slower nominal growth environment. Over the past two years, at least one of growth or inflation has been either accelerating or surprising to the upside, giving an extra boost to revenues and profits. Going forward, it is quite likely that neither growth nor inflation will do so.

As seen in July, downbeat sentiment and relatively low expectations increase the potential for squeezes to the upside in risk assets during earnings season so long as results are not as bad as feared. But over time, the macro conditions will dominate. Falling purchasing managers’ indexes, the strong dollar, and waning commodity price imply profit estimates have further to fall from here. We believe that unless there is a fiscal or geopolitical policy change that provides strong cause to believe that revisions will soon turn, this downward pressure will remain a headwind for risk assets.

Exhibit 3: Third-quarter earnings and sales expectations revised lower

Change in S&P 500 estimates from start to end of quarter

Source: UBS-AM, Bloomberg, data as at 30 September 2022

The equity risk premium continues to show stocks are expensive relative to bonds, and more cuts to earnings estimates are likely to come. Meanwhile, central bankers in the UK and Europe are more willing to protect against disorderly spikes in bond yields. The risk/reward of bonds and credit is improving relative to equities.

We remain defensively positioned within equities. Regionally, we now prefer long positions in US stocks versus other developed market stocks on a currency unhedged basis. Global activity is decelerating, and the earnings growth of US-based companies is less cyclical than other regions. US equities may be more vulnerable should real yields continue to trend higher, since they are more expensive and exposed to the growth factor. That is why it is important, in our view, to have a currency unhedged exposure, as the US dollar would also likely strengthen if real yields climb, offsetting some of the potential underperformance on the equities side.

Our conviction in long US dollar positions remains intact. We believe that sufficiently negative domestic-oriented catalysts for the dollar nor positive catalysts outside the US are likely to gain much prominence in the tactical investment horizon.

Asset class attractiveness (ACA)

The chart below shows the views of our Asset Allocation team on overall asset class attractiveness as of 3 October 2022. The colored squares on the left provide our overall signal for global equities, rates, and credit. The rest of the ratings pertain to the relative attractiveness of certain regions within the asset classes of equities, rates, credit and currencies. Because the ACA does not include all asset classes, the net overall signal may be somewhat negative or positive.

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