Let's get to Dan Girard, who's with us for the half hour. Dan is the senior multi asset strategist at State Street. He happens to be on the line from Bogata, Columbia. Dan, thanks for being with us. The focus is on this hot reading that we had on the US retail inflation. The FED is clearly behind the curve here and they have adopted very very hawkish language to try to get the market in line. How much more downside risk is there right now for the equity space? Oh, I think
quite a bit. And I think that what's actually fascinating about this is that the market really isn't listening. I've been thinking this for a little while that we've had all the pieces of the puzzle come together here. We had FED minutes which explicitly said that inflation could be entrenched if the public questions their resolve of the committee.
And then we had jobs numbers that were blistering, And now we've got inflation numbers that really show this is entrenched, and the market still is sort of thinking this is a race to neutral or a little bit above new role um kind of of a play here. This isn't FED speak. The feed is telling us now directly that they will march higher um, well into the restrictive zone
to try to get prices under control. And let's keep in mind the rates are still a comminative in this period where we're seeing some of the largest inflation of our generation. Fundamentally, Danniel will will that policy work. It's going to be really hard, um. And this is the problem. This isn't monetary. This you know, a complete something in the control of monetary policy. Because of this COVID position, we're in supply chain issues where we're coming from the
floor off the bottom of zero rates. UM. This is going to be very difficult, and the only way they can do it is by significantly impacting the jobs market or significantly impacting demand much much more than they're going to be able to with rates in these kind of positions. So when you hear something like mild recession that you're going to adamantly disagree with that that it's going to be much more severe, UM, I think that they're going to have to try. UM. Maybe to put that in perspective,
it's not about the recession. It is about how they're going to try to get inflation under control. By having to bring demand way down or to loosen this job's market up quite a bit. If we think that they need to get to five percent unemployment UM and that's still within their mandate a full employment under NAHRU, then that's something like two million jobs added UH a looser which could come through participation, or it could come through
job losses or somewhere in between. And that's a big number considering where participation already is with with prime earners. You know, we I don't think anyone expects we're going to get the fifty plus crowd to uh you know, post World War two participation levels in the economy. That
is going to be tough to achieve. And it's the process that is going to be really the problem here getting there talking about the Federal Reserve, does you know this very tight labor market at the moment, then really give the Federal Reserve the license to really, really really be aggressive. Yes. And and this is I think a point that UM bond investors or the markets are missing a little bit, this idea that we're going to get this UM curve in version and UM in the place
to be a longer duration right now. I don't think that's the case right there, because the FED actually needs to loosen up the labor market and actually has to work towards slowing this economy. UM. The curbing version is a is a an expect expression of expectations that the FED will eventually have to cut into the downturn, which I don't think they're going to shift to so soon. That means that this labor market is really the key here. They have got to get this thing looser somehow or another.
And that is going to mean that probably fixed income UM is the biggest risk asset actually right now as they work towards creating a weaker economy, and UH in credit markets and rates markets adjust to that. So we began the conversation by acknowledging downside risk for the equity space. And if you're saying to me, now, hey, there's more downside possible in the fixed income arena, where do you put capital to work to derive any type of return right now? Yeah? It's it's not an easy one, is it.
I think that the place to be is in inflation sensitivity. Right now, we know that China is going to try to UM control the downward growth expectations that are that are coming into this COVID policy. So this new credit expansion of this idea that they're going to have to stabilize their property markets and go to their traditional playbook of infrastructure build. Along with the fact that the US housing situation that we have right now is just as much supply as it is demand, means that I think
the pressure on based materials. Materials in this inflation sensitive environment is actually the place to be, whether that's through the equity markets, um even in energy in places and energy, or through commodities themselves is probably your best bet for now. Balance that with some really solid defensive companies that have
global pricing power and healthcare. And healthcare I think is the one the anti cyclical area that actually benefits from all this with the aging population and with the with the M and A that will happen in this space for efficiency and earnings starting off of course Thursday, US time, these banks are coming up probably not so great to look at those, but other companies forward guidance is going to be absolutely vital, that's right, and I think earnings
is actually gonna hold up quite well. Um, the banks, especially the ones with trading revenue, will actually appear to do quite well. I'm not sure investors will pay up for that. Trading revenue, UM, lending revenue will be challenged. But it's really the guidance and that's right, it's how much are they going to try to kitchen sink this here and try to get people's expectations lower given the fact that they know what's coming a tougher environment ahead. Um,
it's gonna be one to watch. I think that Q two does just fine. Uh. And really we start to see the Q three guidance come down and analysts put in hope for Q four in the holiday season. Uh, and that's going to be really where the risk lies is if we get those those earnings that come in through through Q four, which we'll find out about in early twenty three. So tighter policy when it comes to the FED has generated a lot of dollars strength here, and I think the consensus is this has created quite
the headwind from multinational firms. Is there a way to kind of protect yourself in some way from from a lot of the dollar strength that we have seen? Um, the dollar strength is going to continue, and um, you know it's just going to be it's it's those those assets that are going to be looking for the relative safety of the US through the better profitability of US. And it's really the emerging markets that are going to in some ways pay the price here is they have
to really balance this conundrum of inflation versus growth. Um they've tried to get ahead of the situation for most of let's say, most of Latin America, especially in Asia, we've got countries that are still a bit behind the curve and inflation, like Korea. They're going to have to really work harder to get to get rates higher there as well as growth starts to fade. So there's no easy way, and I think that we need to really continue to watch out for the emerging markets capital flow story,
especially as as the dollar keeps its strength. Thank you so much for joining us down. That was Daniel Gerard, senior multi asset Strateages at State Street getting the latest on the markets.