global perspectives

Debunking market myths – part II

Debunking market myths – part II
François Chareyron - Portfolio Manager

François Chareyron

Portfolio Manager
Florian Ielpo - Head of Macro, Multi Asset

Florian Ielpo

Head of Macro, Multi Asset


In the latest instalment of Simply put, where we make macro calls with a multi-asset perspective, we ponder three myths that are likely to influence markets in 2023. They relate to inflation, recession and the impact of monetary policy on markets.  


Need to know:

  • Inflation breakevens can be a biased measure of inflation expectations, especially when inflation starts to roll over, as is happening now
  • A recessionary period can include quarters of positive GDP growth, which may cloud judgement when calling a recession
  • A dovish pivot has historically been bad news for equities, credit spreads and commodities – maybe investors should not really be looking forward to this


As a celebration of our end-of-year piece for 2021 − “Bubbles, inflation, negative breadth: which market myths matter for 2022?” − François Chareyron and I are returning to one of our favourite pastimes, offering our quantitative take on some of the dominant themes the media concentrated on in 2022. This year, we focus our attention on challenging three ideas: inflation, recession and the impact of monetary policy on markets. We think these topics are likely to shape asset performance going into 2023, which will probably be another challenging year, but then what year isn’t? Game on.


Are we measuring inflation expectations correctly?

Sometimes beliefs are forced into investors’ brains, never to be reconsidered again. “Volatility = risk” is one of them but there are plenty of others. In our opinion, “breakeven inflation rates = inflation expectations” is another one. We disagree with this idea, and the difference between inflation swaps rates and inflation breakevens, in our view, says a lot about how this latter measure should be taken with a heavy pinch of salt. Inflation linkers incorporate a feature that inflation swaps do not: a deflation floor. Over the lifecycle of the bond, should inflation prove to be negative then the bond holder is guaranteed not to lose money because of that optionality. The inflation used to calculate the final payoff of the bond is floored at zero, to protect investors against deflation. That option has a value that varies depending on the period, and moments when inflation is high-and-mean-reverting can typically be periods when the value of this option rises. As this happens, the price of the bond increases and the implied inflation rate – the “breakeven rate of inflation” – declines. This does not happen with an inflation swap, as it does not benefit from this feature. In simple terms, when looking at “market-based” measures of inflation expectations, inflation swaps should be preferable to inflation breakevens, as when inflation starts fluxing back, the likelihood is that deflation increases and breakevens’ inflation rates will underestimate genuine inflation expectations. Chart 1 illustrates the difference between two maturities and how this difference, at times such as today, can be misleading (by a material 25 bps). The Federal Reserve’s (Fed) 5-year x 5-year forward expected inflation analysis specifically deals with this feature: so investors should follow the eyes of Fed, not those of the breakeven-addicts.


Chart 1. US inflation swaps vs. inflation breakevens

Multi-Asset-simply-put-US inflation swaps vs inflation breakevens-01.svg

Source: LOIM, Bloomberg


Recessions happen with positive GDP growth

There are also pervasive myths when it comes to recessions. Recessions are periods of contracting economic activity, but these contractions do not usually occur in straight lines and their persistence can vary a lot too. There are two key points that we think should be taken with caution on entering 2023:

  • Firstly, dating a recession is more complex than simply two consecutive quarters of negative GDP growth. Recessions have historically shown a wide variety of duration, and the shortest we have seen was the 2020 recession that actually only lasted for one quarter. Neither the National Bureau of Economic Research (NBER) nor the Centre for Economic Policy Research (CEPR) date recessions this way, but instead emphasise the variety of criteria that should be taken into account: “depth, diffusion, and duration,” as the NBER puts it in its Q&A section. Every recession is different, which means that identifying them is more complicated than a sequence of two consecutive GDP numbers and will likely make our lives difficult next year.
  • Secondly – and maybe more surprisingly – during recessions quarters of positive growth can occur and have been identified. For instance, Q2 2008 – the second quarter of the 2008 US recession – was a period of growth (+2.3% of annualised). Chart 2 illustrates how this is actually a common occurrence: out of the 40 quarters of recession since 1950 in the US, a third of them showed positive periods of growth, with an average value slightly above 2%. Recessions are not just periods of GDP contraction, and the nowcasting indicators we publish every week have been built on that basis.

Negative growth does not wholly encompass a recession, and it might be pertinent to keep this challenge in mind when trying to assess the risk of a recession in 2023.


Chart 2. Frequency of positive and negative GDP growth during recessions and average variations when positive and negative (right).

Multi-Asset-simply-put-Pos-neg GDP growth-01.svg

Source: Bloomberg, LOIM


Fed pivot versus Fed moderation

The expression “Fed pivot” has attracted a lot of attention recently – with some investors either welcoming or dreading that moment. The most common definition of a central bank pivot is “when the […] central bank reverses its policy outlook and changes course from expansionary (loose) to contractionary (tight) monetary policy – or, conversely, from contractionary to expansionary.” (Investopedia). When a central bank is as hawkish as the Fed is today, it can do so either by cutting rates – and surprising markets – or by signalling it will be cutting rates at its next meeting (absence of plural intended). When that dovish pivot happens, it usually means that the economy and markets are doing poorly, as illustrated by Chart 3: equity performance is usually better when the Fed is hawkish than when it is dovish, while it is the other way around for bonds. Therefore, a dovish pivot from the Fed may not be the moment to add to equities but rather to increase fixed income allocations. Yet, 2022 has been an exception to that pattern and the Fed’s current moderation is already being described by some as a pivot, since it opens the door to less aggressive monetary policy, and should be supportive of equities. We believe that distinguishing between a genuine pivot and a moderation of hawkish policy can make a difference in terms of market reaction, which will be especially relevant as 2023 dawns.


Chart 3. Annualised returns when the Fed is either more hawkish or dovish than expected from 1990 to 2022

Source: LOIM, Bloomberg.


  Simply put, inflation, recession and central bank risks are likely to shape next year’s asset returns once more.  


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:

  • The deterioration of growth conditions continues, but that situation does not seem to be influencing central banks.
  • The inflation nowcaster is negative for China and the US. Its decline is intensifying and is even decreasing in Europe.
  • Central banks’ hawkish stance should remain: the European Central Bank and the Fed’s statements were a clear indication of that.


World growth nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Growth nowcaster-5Dec-01.svg


World inflation nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Inflation nowcaster-05Dec-01.svg


World monetary policy nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Monetary Policy nowcaster-5Dec-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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