“We do believe that in the coming decade, inflation will trend higher than the past two to three decades,” said Didier Borwoski, head of macro policy research at the Amundi Institute during an interview with Delano, held prior to Thursday’s European Central Bank rate decision. Borowski anticipated hawkish communication from the ECB and said that the energy crisis has had a “structural shock” on households’ purchasing power.
That being said, Borowski noted that “certain segments of the European equities markets are strongly derated,” or undervalued, such as European small-caps. Europe is the “epicentre” of the energy crisis, and “the impact of the energy crisis on profits has not fully materialised yet,” he said.
European equity markets have increased too rapidly, in Amundi’s view. Therefore, “we expect a market correction in Europe,” said Borowski, which may then lead to “interesting entry points” for equity investors, perhaps in the second half of the year. “We are no longer as short as we were on European equities,” said Borowski. “We tend to prefer now the European equity markets to the US equity markets.”
Now we have entered in a phase where we expect fixed income markets to offer some value.
However, depending on geopolitical developments such as Russia’s war in Ukraine, the energy crisis, inflation or how corporate earnings evolve in the coming quarter, things could change rapidly. “We need to be very agile and flexible in terms of asset allocation,” said Borowski. “It’s all about active, very active, management of your equity portfolio in the eurozone.”
“Bonds are back”
Borowski mentioned two points regarding the European bond market. First, given sticky core inflation, the ECB is likely to remain hawkish in the coming months. Secondly, governments will massively issue bonds this year in Europe, “so risks to bond yields are slightly skewed to the upside.” The ECB will also purchase less sovereigns than last year, meaning that the private market will need to absorb this issuance.
“Something which is important is that the bulk of the adjustment on bond markets is behind us,” noted Borowski. Last year, inflation led to a strong correction in the fixed income markets. “Now we have entered in a phase where we expect fixed income markets to offer some value.” Since October, Amundi’s mantra has been, “Bonds are back.”
“There is still value in the fixed-income market,” highlighted Borowski. “This market segment is still cheap by historical standards.” But investors need to be increasingly selective.
The rebound of the euro
“The euro excessively depreciated,” replied Borowski, in response to a question about how the euro has rebounded after reaching parity with the US dollar last autumn. This can be partly explained by last year’s skyrocketing gas prices, which reached record highs in August 2022. But it is partly structural--energy prices will likely remain higher than they have been the past few years. Amundi expects the euro to reach $1.15 by the end of the year.
As mentioned regarding European equities, “we see that some market segments are undervalued in Europe,” said Borowski. “There is a geopolitical risk premium on European equities.” Signs of stabilisation in Europe may encourage foreign investors to reposition themselves in European assets, so “risks, for us, are skewed upside when it comes to the euro.”
Borowski, however, added a note of caution. Because part of the shock is structural, and that energy prices will likely remain higher than they were before Russia’s war in Ukraine, it’s important to separate what is structural from what is more short-term.
Looking ahead: Europe’s response to America’s Inflation Reduction Act
The European Commission presented on 1 February its Green Deal Industrial Plan. It aims to accelerate the climate transition and is Europe’s response to America’s Inflation Reduction Act, which offers subsidies to support the green transition. Borowski noted that European governments will have to find a way to finance the EU’s Green Deal Industrial Plan, which won’t be easy.
But “if we manage to do that, it will reassure investors that Europe continues to make progress despite the crisis. Europe has always made progress in times of crisis, as we saw during covid, with the SURE programme or Next Generation EU,” said Borowski. “We now need to find a way to finance the energy transition. If we manage to do that in a coordinated manner with some elements of mutualisation, that’s something that will be very well-received by investors, reassured by the fact that once again Europe is making progress.”