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Article | 17 July 2023 | Investments
Jaime Arguello
Chief Investment Officer
The US Federal Reserve (Fed) paused its rate-hiking stance for the first time in 14 months and indicated that investors should expect two more hikes in 2023. Despite this, recent inflation data have proved benign. Elsewhere, the European Central Bank (ECB) continued tightening even as eurozone inflation eased, while the Bank of England was forced to accelerate its pace of rate hikes to deal with high wage and pricing pressures. The People’s Bank of China cut a key borrowing rate, which it is hoped will help boost consumption. Premier Li Qiang stated that China aimed to grow GDP by ‘around 5%’ in 2023.
Global equities rallied over the period. Among the major markets, Japanese equities led returns, while the US also recorded solid gains which were not just tech concentrated. European stocks also rose, though the UK lagged. US government bond yields rallied, as prices fell, and the difference between 2 year and 10 year bond yields exceeded 100 basis points (bps), a degree of inversion that was last seen in 1981. An inverted yield curve is usually considered a strong predictor of forthcoming recession. The euro strengthened against the US dollar, but the yen continued to weaken as the Bank of Japan made no change to its monetary policy and interest rates remain at -0.1%. The oil price rose slightly to $74.9 a barrel, while the natural gas price rose to a two month high. Gold retreated from the record high set in May.
Architas view
Hawkish rhetoric by the Fed and the ECB leaves the door open for further increases. Money markets futures are indicating rates will be higher for longer, with fewer cuts in 2024 than originally expected. Tighter monetary conditions present a more difficult environment for equities. Moreover, the global macro momentum is weakening, with a decline in global purchasing managers’ indexes (PMIs). Manufacturing is in a slight recession, while activity in the services sectors is also easing. Despite this, the labour market and wage growth are still firm. Disinflation is continuing at a slower pace, while core inflation is proving resilient in the developed world, especially in the eurozone. We are seeing a divergence in economic data, surprising on the downside in Europe and China, but showing greater resilience in the US.
Within equities, we remain neutral overall, but near term expect material outperformance from the US versus the eurozone. This reflects more sluggish GDP growth expectations for the eurozone, the likelihood of relatively more rate hikes from the ECB and the composition of both equity markets. A higher growth but lower cyclical/value focus should benefit US equities. We favour quality and growth companies in our portfolios but are avoiding funds with high exposure to the stocks that benefited the most from the ’AI induced rally’, as this could cool.
On fixed income, we maintain our neutral position on US government bonds. We believe that the US 10Y yield should stabilise in the 3.75%/4.25% range. Also, we still think that in the event of a more volatile period for equities or a more dramatic slowdown in growth from here, US Treasuries should provide a good hedge or protection in multi-asset portfolios.
We remain moderately cautious on European government bonds, as the ECB remains on the backfoot in the fight against inflation. Interest rate hikes could be higher than expected by the money markets.
We also remain moderately positive on investment grade credit and emerging market debt, reflecting their attractive levels of credit spreads and yields and relatively improving performance.
We maintain a neutral stance on global high yield bonds (HY). However, in terms of portfolio construction for Euro currency based portfolios, we think that European HY should be favoured as the average yield is higher versus US HY due to hedging costs, and the average credit quality of European HY is also better.
