UBS: Has the market priced in "slow inflation"?

According to the Zhitong Finance APP, recently, UBS released a research report on global strategies, deeply exploring the market's pricing of "Slowflation," a phase that is neither a recession nor characterized by high inflation and negative growth coexisting as in "stagflation." How is the current market pricing this risk? UBS analyzes this through three dimensions: credit spreads, industry differentiation, and cross-regional relative value, providing strategic guidance for investors.

Concept of Slowflation and Market Status

UBS points out in the report that the current market may be entering a "Slowflation" phase, where economic growth is slowing (but still positive) while inflation remains at a high level. This phase is characterized by a significant divergence between soft and hard indicators of economic growth, and inflation expectations are rising due to aggressive tariff policies and other factors, although long-term inflation expectations have not changed significantly.

In contrast, the definition of stagflation is more severe. In this scenario, economic growth is nearly stagnant or even negative, while inflation remains high, bringing great instability to the economy.

The current state of the U.S. economy aligns with the characteristics of Slowflation. The GDP growth forecast for 2024-2025 is expected to decline from 2.3% to 2.0%, indicating a trend of slowing economic growth. However, the core inflation rate remains above the Federal Reserve's target level, suggesting that inflationary pressures still exist. In this context, the market needs to closely monitor changes in economic data and potential adjustments in monetary policy by the Federal Reserve to address potential economic risks.

U.S. Market Analysis

The current credit spreads for U.S. investment-grade (IG) and high-yield (HY) bonds are 90 basis points and 317 basis points, respectively, which are 13 basis points and 61 basis points higher than the tightening levels of 2025. UBS's analytical framework shows that the market's pricing of Slowflation risk is approximately 30% in IG and 10% in HY. In IG, issuers in the insurance (67%) and energy (46%) sectors have a higher pricing for Slowflation; in HY, the transportation (43%) and telecommunications (40%) sectors show a higher pricing for Slowflation.

Although the overall market's pricing for Slowflation is not high, some industries have already exhibited typical return characteristics under a Slowflation environment. In both IG and HY, the telecommunications sector and the 7-10 year segment of the yield curve perform particularly well. UBS maintains a bullish outlook on the HY telecommunications sector and a bearish view on the HY food and beverage sector, which aligns with its assessment of the high and low pricing for Slowflation in its framework.

European Market Analysis

The current credit spreads for European IG and HY bonds are 92 basis points and 307 basis points, respectively, which are 7 basis points and 36 basis points higher than the tightening levels of 2025. UBS's framework shows that the European IG market prices Slowflation at about 60%, while the HY market prices it very low (<5%). In IG, issuers in the utilities (86%), insurance (77%), and banking (68%) sectors have a higher pricing for Slowflation; in HY, only the banking (32%) and capital goods (28%) sectors show signs of Slowflation In the investment-grade (IG) market, most sectors, curves, and ratings have shown typical returns under a slow inflation environment, except for energy and the front end of the yield curve (1-3 years). In the high-yield (HY) market, returns for most sectors, except for the financial sector, differ significantly from the typical returns in a slow inflation environment, particularly for CCC-rated bonds and the capital goods sector. UBS believes that the fair value of the European IG/HY spread should slightly widen, around 95-100 basis points and 300-325 basis points, respectively, maintaining a bullish outlook on the financial sector and a bearish view on the materials sector.

Relative Value Analysis of the US and Europe

From a relative performance perspective, since the beginning of the year, the European credit market has outperformed the US by 1.28% in IG and 1.42% in HY. In IG, UBS's model shows that only high-quality issuers and the 7-10 year segment of the yield curve appear relatively cheap in the European market; in HY, most sectors are close to or below their 25th percentile during slow inflation periods, making European HY appear more vulnerable compared to US HY, with CCC ratings (which have strong specificity in Europe) being an exception.

Risk Warnings and Conclusions

UBS also mentioned the risks of multi-asset investments in its research report, including market risk, credit risk, interest rate risk, and foreign exchange risk. Geopolitical events and policy shocks may also pose risks to asset returns. Additionally, the correlation of returns between different asset classes may deviate from historical patterns, and valuations may be adversely affected during periods of high market volatility, weak liquidity, and economic turmoil.

Overall, UBS believes that the current market pricing for slow inflation remains insufficient, especially for high-yield bonds and certain sectors. Investors need to seize structural opportunities amid volatility: betting on mispriced sectors (such as HY telecommunications), leveraging regional differentiation (US-Europe HY spread), while being cautious of marginal changes in macro data. This strategic framework provides a clear path to address "non-recessionary slowdown."