Our expectation has been that the ECB will follow the Fed’s pivot later in 2022, and begin the path to normalize policy thereafter. Until last week this view was not shared by the central bank nor by most investors. ECB President Lagarde’s shift in tone at last week’s press conference included a focus on the need for optionality in policy and concerns about inflation. Market expectations immediately began to adjust in line with what we had been suggesting.
A recent webcast discussed the potential for this pivot, as well as its ramifications across asset classes. With the ECB forced to begin a sustained interest rate hiking cycle in 2023, if not earlier, the implication is that the developed world will experience a synchronized rate cycle for the first time since the Great Recession. We noted that this will come as a surprise for most investors and contribute to a material rise in global bond yields. Competitive currency appreciation may help contain inflationary pressures but swings will be limited. Euro area equities (particularly the financial sector) are cheap and should be a relative beneficiary in a rising interest rate environment.