investment viewpoints

2023 has begun with an inflation-relief rally

2023 has begun with an inflation-relief rally
Florian Ielpo, PhD - Head of Macro, Multi Asset

Florian Ielpo, PhD

Head of Macro, Multi Asset

In the latest instalment of Simply put, where we make macro calls with a multi-asset perspective, we examine the current equity rally and its relationship to the decline in inflation.  


Need to know:

  • Inflation is currently retreating at a fast pace
  • This inflation decline has fueled an inflation-relief rally: the first 15 days of January have been showing a strong performance
  • Inflation pricing was out of the ordinary in 2022 and this has carried into January. Markets’ attention will shift again


The start of the year looks much better than that of 2022. In about 15 days of trading, markets have managed to gain about 5% (MSCI World), which makes of this month strong in terms of equity performance. Beyond this out-of-the-ordinary performance, it is essential to understand the contributing factors: are we seeing a fundamental recovery rally or is the market buying something irrational? Many investors are still underexposed and should be wondering whether we are witnessing a burgeoning recovery (as in 2019) or if this is another of these bear market rally phases. For now, we are seeing evidence that what motivates this rally is a relief sentiment - the relief that inflation seems to be fading, with what seems to be the inevitable conclusion a central bank moderation, if not a pivot. Let us take a more detailed look at this inflation relief rally and assess how rational it is.


Inflation makes the price action

We need to understand the factors underpinning the recent evolution of markets before trying to understand what is happening on the inflation side. This is all the more important, given last year was extraordinary. Figure 1 shows the explanatory power of inflation and growth surprises across asset classes and is a follow-up on the S&P500 specific analysis from our Q1 Simply Put Quarterly. Last year stands out as a one-of-a-kind year, when embracing the importance of inflation surprises in 2022 across all asset classes:

  • From 2016 to 2021, inflation explains less than 5% of the performance of asset classes. The situation in 2022 is clearly different. The average R2 across equities, bonds, credit and commodities revolves around 35%, a large multiple of the estimated value over the preceding period. Investors largely ignored inflation over the past 5 years, and 2022 showed a significant change, from a cross-asset perspective.
  • The sensitivity of global markets to growth is also strikingly different in 2022 from over the 2016-2021 period. In the past, growth explained 19% of the performance of returns across asset classes, and that number in 2022 collapsed to 6%.

In simpler terms, there are strong statistical evidence that investors became inflation-focused in 2022, and that their attention was driven away from growth. This happened for good reasons, as inflation got abnormally high, but is today’s situation the same? Should we be still collectively inflation maniacs?


Figure 1. Explanatory power of inflation and growth surprises over asset classes’ returns

Multi-Asset-simply-put-Inflation and growth-01.svg

Source: LOIM, Bloomberg. Based on regressions of returns on Citi Surprise Indices.


Inflation is coming down

Figure 2 shows how the relief rally is actually supported by hard evidence: inflation is not only declining, but also surprising us to the downside. That situation was with us across Q4 and looks persistent. If inflation fears are responsible for a large part of the decline in markets last year (alongside rising real rates which is the flip side of this inflation coin), it only looks reasonable that this decline in inflation should support market bullishness for now. If you are still doubting this disinflation period is supported by fundamental factors outside the decline in commodity prices, take a look at our inflation surprise nowcaster below:

  • It has been declining since June;
  • It now stands at a deep sub-50% level;
  • Worldwide, 56% of the data behind our nowcasting indicator is still declining.

The cross-section of all these elements offers a compelling story on inflation: inflation has been a key factor priced by markets last year and probably also in January. Inflation is coming down hard at the moment, and investors are quite naturally relieved at this situation, given the level of scares it had generated. All of that looks very rational.


Figure 2. US inflation surprises and variations

Multi-Asset-simply-put-Inflation and variations-01.svg

Source: LOIM, Bloomberg


Cautious but not defensive

However, inflation is maybe no longer where your attention should be. If that disinflation trend continues, maybe that risk should be put on the side for a moment. This is not to say that we should be dismissing the risk that inflation could prove to stay higher than 2% for a longer period of time.Maybe we should try to understand why inflation is coming down so rapidly – and how it could be one of the indications that the world economy is slowing down at a fast pace. Take a closer look at our growth nowcaster at the bottom of this publication to see how the currently slower growth conditions are now affecting a majority of the world GDP. For now, sentiment is in the driver seat and the inflation-relief rally is set to continue. Let us just not forget about January 2018, its 5% rally and its end: a harsh year for both inflation and growth reasons. The case for being defensive looks gone for now, but not the case to remain cautious at this moment of the cycle. This is the key outcome of the cross-section of tactical signals we are currently looking at.


  Simply put, the current rally is rooted within the decline in inflation. Let us remember that such an inflation-relief rally does not make a recovery rally and that cautiousness remains warranted for now.  


Macro/Nowcasting Corner

The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick.

Our nowcasting indicators currently point to:

  • Our growth nowcasting indicator remains in recession territories for now, with this week anther decline of the US indicator with a particularly bad batch of data on Wednesday. Our China indicator shows a first uptick.
  • Our inflation nowcasting indicator has declined again, as even in the Eurozone, inflation forces are fluxing back.
  • Our monetary policy nowcaster remains between .45 and .55, but declined again this week as investment, consumption and production expectations data showed signs that the Federal Reserve’s moderation should continue.

World Growth Nowcaster: Long-Term (left) and Recent Evolution (right)

Multi-Asset-simply-put-Growth nowcaster-24 Jan-01.svg

World Inflation Nowcaster: Long-Term (left) and Recent Evolution (right)

Multi-Asset-simply-put-Inflation nowcaster-24 Jan-01.svg

World Monetary Policy Nowcaster: Long-Term (left) and Recent Evolution (right)

 Multi-Asset-simply-put-Monetary Policy nowcaster-24 Jan-01.svg

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).


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