Stagflation risk sinks billions from big hedge investors

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(Bloomberg) – It’s the next big market call that could make Wall Street traders rich: The raging global energy crisis and increasingly hawkish central banks are tipping key economies into 1970s-style stagflation .

It’s a long way off so far, but fund managers fear that this market scenario – runaway inflation just as growth collapses – will eventually come to pass, particularly in Europe.

Global growth optimism is at an all-time low, according to this month’s survey of fund managers from Bank of America Corp. Stagflation expectations jumped to 66%, the highest since 2008. Price pressures in the United States increased in March in the most significant way since the end of 1981.

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Fund managers are increasingly bracing for bad economic news – and nowhere more so than in Europe, belying hopes coming this year that the region will outperform the US Amundi SA is bracing for a possible slowdown on the continent , abrdn Plc is long the US dollar against the euro and Vanguard Group Inc. touts liquidity hedges.

Other popular trades include betting on Australia’s commodity exporters to Canada and betting against bonds rife with interest rate risk.

Why war and its impact on oil are rekindling fears of stagflation: QuickTake

Plenty of bad things have to happen before an investment climate that bears the hallmarks of stagflation transpires, with European Central Bank President Christine Lagarde among officials pushing away that likelihood.

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But one thing is certain: while novice traders have limited experience of real-world inflation, even fewer remember a world of runaway prices and reservoirs of growth.

Even if stagflation-like pressures are limited to Europe, they have the potential to hurt Wall Street traders betting on the international growth story, while evoking memories of the sovereign debt crisis and the lost decade of growth.

The region is the epicenter of concern, given its proximity to the Russian war and weaker domestic growth levers. German breakeven points, a debt indicator of expected price pressures over the next decade, have risen more than a percentage point so far this year. While the market-derived price level for the United States is higher, the rate of change is more than three times higher.

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Below is a collection of fund manager views. Comments have been edited for clarity.

James Athey is a London-based investment director at abrdn, which oversees around £542 billion ($707 billion) in assets. The 42-year-old has run out of euros and pounds.

“The most acute risks of stagflation are undoubtedly in continental Europe.” “As the current account surplus shrinks due to the need to import increasingly expensive energy, their currency will weaken further, increasing inflation and hurting key export sectors. Or they may tighten monetary policy to try to cap inflation and support the currency, but this will crush already weak domestic demand. Either way, their trade-off between growth and inflation looks awful.” most countries will struggle to offer the current highs. The exception is most likely the US. Therefore, we are positioned for steeper curves in Europe and flatter curves in the US. We are long on the US dollar against the euro and the pound sterling.

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Andrew McCaffery, 58, global chief investment officer of Fidelity International, which has $813 billion in assets. Its base case is a European recession and the investor stays away from stocks in the region and the single currency:

“We favor positioning for the high probability of stagflation in developed markets, with a base scenario of recession in Europe.” “Stagflation presents a challenge, but there are some areas in fixed income that we believe will be better protected against higher rates and slower growth. Breakevens should continue to perform relatively well, in the We are also positive on Euro-investment grade, given its more defensive characteristics and the improvement in valuations.

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Henrietta Pacquement, 45, head of the global fixed income team at Allspring Global Investments, says Russia’s invasion is a game-changer for Europe. The London-based investor cites shorter-dated bonds and floating-rate bonds as potential hedges against stagflation.

“Stagflation is a scenario you need to consider. You still have upward inflationary pressures as well as downward pressures on growth. Does it push economies into stagflation or even recession at a later stage? The question is still open. We clearly still see the tailwind of the post-pandemic opening up of the economy. “There is a lot of volatility in the interest rate market. Meanwhile, credit markets have performed reasonably well. We have seen new issues hitting the market with attractive premiums and I believe this is a trend that will continue periodically throughout the rest of the year. ”

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Malvern, Pa.-based Arvind Narayanan, co-head of investment-grade credit at Vanguard, which oversees around $8 trillion, sees higher risks of stagflation globally as Europe faces pressure the strongest on prices.

“The intention of central banks is to slow inflation and the only way to do that is to reduce aggregate demand, but that will take time.” decline in credit and in global emerging market type exposure to get that extra yield to outperform. Now the world is different. “”You want to underweight duration and credit exposures – and shore up your portfolios with sufficient liquidity, as this transition will not be smooth. “

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Lynda Schweitzer, Boston-based portfolio manager and co-head of the global fixed income team at Loomis Sayles & Co., doesn’t entirely buy into the stagflation story, but she remains concerned.

“It is certainly disappointing that we are marking growth at the same time as we are increasing inflation.” talked about quite significantly is what all of this means for emerging markets – for commodity-linked countries where the terms of trade have risen with rising commodity prices.

Akira Takei, global fixed income manager at Asset Management One Co. in Tokyo, also sees the greatest risk of stagflation in Europe and the UK

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“Rising gas prices have led to a spike in European inflation.” “Given that the ultra-long end of yield curves has already flattened considerably, mid-tier notes have upside potential in the UK and Eurozone. The BOE has led other central banks to raise rates , but the risks to yields are no longer one-sided. I see a strong chance that two- to five-year notes will start pricing in Bank of England rate hikes in the future crisis.”

Vincent Mortier, Paris-based group chief investment officer at Amundi, which oversees more than $2 trillion in assets, favors a neutral stance on global equities and a defensive allocation to credit as Europe becomes increasingly no longer the epicenter of stagflation risks.

“An earnings recession is possible in Europe even before an economic recession sets in.” “Weak technicals, underscored by a combination of factors such as the withdrawal of central bank support, rising rates and pressure from economic growth, call for a defensive allocation to credit. Continued inflation calls for a tilt positive on sensitive assets in the form of inflation-linked bonds, gold, some real assets.

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