This is an excerpt from Santander Investment Services Q4 Global Market Outlook.   For more information on how the markets are reacting to inflation, read the full report here.  

Since the central bankers' symposium in Jackson Hole at the end of August, monetary authorities have attempted to address inflation with interest rate hikes. However, economic activity in the United States remains too robust and inflation persists.

Europe, however, continues to experience inflationary tremors with energy prices at the epicenter. Doubts about energy supply cast a shadow over the growth outlook, and leading indicators of economic activity point to a significant slowdown in the coming quarters. In China, the repercussions of the property market adjustment continue to have a negative impact on the economy.

The dynamics of high inflation and lower growth still persist, and investors may want to maintain a defensive tone in their portfolio risk allocation.
 

Still more work to do to fight inflation

Concern around the harmful effects of high inflation levels has reached heights unseen in recent decades. In Europe, uncertainty about energy supply has increased throughout the third quarter. Rising gas and electricity prices signal a difficult winter in terms of inflation figures and household budgets. In the United States, a turning point is beginning to emerge, but the concern is shifting to services inflation.
 

Lower growth is the price to pay

The three main economic blocs (U.S., Europe, China) will bear the needed cost of economic growth to mitigate the effects of economic policy errors. In the United States, the Fed assumes that it is necessary to slow down the economy in order to avoid inflationary risks arising from supply chain imbalances and from excessive monetary stimulus. In Europe, the geopolitical mistake of energy dependence on Russia will take its toll in the coming quarters, and the Chinese authorities face the difficult task of stabilizing the real estate sector and health risks. The market is beginning to assume the cost in global economic growth needed to stabilize inflation (United States), energy supply (Europe), and real estate leverage (China).
 

The adjustment in earnings is lagging

Fixed income markets have heard the message from central banks and have taken on greater doses of monetary tightening. The dramatic tightening of interest rates is already raising hopes of a turnaround in inflation and yields for high credit quality bonds begin to look attractive. The adjustment in terms of growth is still incomplete and a deterioration in the performance of the most cyclically sensitive assets (credit and equities) is foreseeable. We maintain a defensive bias pending the adjustment in earnings expectations.

For more details on how the global markets and the United States market is responding to these shifts, read the full 2022 Q4 Market Outlook.