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Credit Matters

Is Goldilocks back?

July 2022


Markets rallied in July as recession fears outweighed inflation concerns – leading investors to believe that the ongoing aggressive monetary tightening will soon come to an end. The goldilocks environment where the economy is not too hot to warrant substantially higher interest rates, nor too cold to cause a recession, seems to be back after being prominent in the post 2007-08 Financial Crisis years.

Lower inflation expectations also fed hopes of a future central bank dovish pivot. This came on the back of falling oil prices, with WTI futures trading at $100 per barrel at the end of the month, down from $122 in June. Hopes of lower disruption in global supply chains also increased expectations of easier monetary policy ahead. The US Fed said in a paper that supply factors account for about half of the run-up in current inflation levels – hence any improvement in the post-Covid supply troubles should bring inflation down.

Both stocks and bonds gained, with the tech-heavy Nasdaq index posting double-digit gains. Long duration assets, including long maturity sovereign debt also outperformed. The UK and Italy didn’t rally as much, following the resignation of Boris Johnson and Mario Draghi – with the latter renewing concerns about a European Union break-up. In order to counter such fear, the European Central Bank (ECB) unveiled a programme by which it will be allowed to buy bonds of financially challenged countries. The ECB also lifted rates for the first time in more than a decade.

High Yield outperformed Investment Grade in the US, lifted by narrowing spreads and a rather positive earnings season. In Europe, corporate bonds posted their best month ever, helped by the underlying base/sovereign rate rally and as yearto-date (YTD) losses have left some debt attractively valued.

More stable and short-duration assets such as loans and Asset-Backed Securities lagged. Asian assets suffered amid China’s real estate woes, triggered by a mortgage payers’ strike.

The US dollar continued to ascend, taking its YTD gain against the euro, the yen and sterling into double-digits.

Some market observers question the risk-on market mode, arguing that the Fed is still on a tightening cycle – it raised rates by 0.75% in July – and that leading indicators are signalling a recession. Others believe that goldilocks is back.



Source: Bloomberg as at 29 July 2022.