UBS: Has the market set a price for “slow inflation”?

The Zhitong Finance App learned that recently, UBS (UBS) published a research report on global strategies to thoroughly explore the market's pricing of “slow inflation” (Slowflation). This stage is not only different from economic recession, but also from “stagflation,” where high inflation coexists with negative growth. To what extent is this risk currently being priced in the market? UBS analyzes the three dimensions of credit spreads, industry differentiation, and cross-regional relative value to provide strategic guidance to investors.

The concept of slow inflation and the current state of the market

UBS pointed out in the research report that the current market may be entering a “slow inflation” phase, where economic growth is slowing down (but is still growing positively), while inflation remains at a high level. This stage is characterized by clear differences between soft indicators and hard indicators of economic growth data. Inflation expectations have risen due to aggressive tariff policies and other factors, but long-term inflation expectations have not changed significantly.

By contrast, the definition of stagflation is more stringent. Under such circumstances, economic growth almost stagnated or even experienced negative growth, while inflation remained high, causing great instability to the economy.

The current state of the US economy is characterized by slow inflation. The GDP growth forecast for 2024-2025 slowly fell from 2.3% to 2.0%, indicating a slowing trend in economic growth. However, the core inflation rate is still above the Federal Reserve's target level, which means that inflationary pressure remains. In this context, the market needs to pay close attention to changes in economic data and possible monetary policy adjustments by the Federal Reserve to deal with potential economic risks.

US market analysis

US investment grade (IG) and high yield (HY) credit spreads are currently 90 basis points and 317 basis points respectively, 13 basis points and 61 basis points higher than the 2025 level of austerity. UBS's analytical framework shows that the market prices the risk of slow inflation at around 30% and 10% in IG and HY, respectively. In IG, issuers in the insurance (67%) and energy (46%) industries price slow inflation higher; in HY, the transportation (43%) and telecommunications (40%) industries price slow inflation higher.

Although the overall market does not price slow inflation well, some industries have shown typical return characteristics in a slow inflation environment. Among IG and HY, the telecommunications industry and the 7-10 year portion of the yield curve performed particularly well. UBS maintains a bullish view of the HY telecom industry and a bearish view of the HY food and beverage industry, which is consistent with its assessment of slow inflation pricing in its framework.

European market analysis

European IG and HY credit spreads are currently 92 basis points and 307 basis points respectively, 7 basis points and 36 basis points higher than the 2025 level of austerity. UBS's framework shows that the European IG market prices slow inflation at around 60%, while the HY market prices slow inflation very low (< 5%). In IG, utilities (86%), insurance (77%), and banking (68%) issuers priced slow inflation higher; in HY, only banking (32%) and capital goods (28%) showed signs of slow inflation.

In IG, with the exception of the front end of the energy and yield curve (1-3 years), most industries, curves, and ratings have shown typical returns in an environment of slow inflation. In HY, with the exception of the financial industry, there is a big difference between the returns of most industries and typical returns in an environment of slow inflation, especially CCC ratings and the capital goods industry. UBS believes that the fair value of the European IG/HY spread should expand slightly, to around 95-100 bp and 300-325 bp, respectively, and maintain its bullish views on the financial industry and bearish on the materials industry.

Analysis of the relative value of the US and Europe

In terms of relative performance, since the beginning of the year, the European credit market has outperformed the US by 1.28% and 1.42% in IG and HY, respectively. In IG, UBS's model shows that only high-quality issuers and the 7-10 year portion of the yield curve look cheaper in the European market; in HY, most industries are close to or below their 25th percentile during the period of slow inflation, making European HY more vulnerable than US HY. The CCC rating (which is very specific in Europe) is an exception.

Risk Alerts and Conclusions

UBS also mentioned the risks of multi-asset investments in the 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. Furthermore, the return correlation between asset classes may deviate from historical patterns, and valuations may be adversely affected during times of high market volatility, weak liquidity, and economic turmoil.

Overall, UBS believes that the current market's pricing of slow inflation is still insufficient, especially high-yield bonds and some industries. Investors need to seize structural opportunities amidst fluctuations: bet on pricing mismatch industries (such as HY Telecom), take advantage of regional differentiation (HY spread between the US and Europe), and be wary of marginal changes in macro data. This strategic framework provides a clear path for dealing with a “non-recessionary slowdown.”