Investments | 21 November 2022
Monthly update: When will the big interest rate hikes end?
Some markets seem less spooked by rising inflation and interest rates. Here’s why…
WHAT’S HAPPENING IN FINANCIAL MARKETS?
Every inflation announcement this year has been a big day for investors, though Coutts actually think investors should be looking at company earnings instead, but for most inflation remains the big focus.
When US inflation data came out in October we saw an interesting turnaround. Inflation came in hotter than expected and the country’s stock markets swooned, but they soon recovered and rallied.
Coutts Head of Investment Strategy Sven Balzer said: “Markets know the Fed (US Federal Reserve) can’t continue hiking at the current 0.75% pace forever. That pace has to slow.
“At its November meeting the Fed alluded to this ‘peak of pace’. Of course, current US inflation of 8% is not a number it can live with. But the US housing market is at a standstill, commodity prices have fallen and company inventories are rising while demand drops. So looking into 2023, a slowing economy and declining business activity should gradually negate the need for big rate hikes.”
Another reason stock markets recovered was that the Q3 company earnings season, although weak, was no worse than expected. Weaker earnings will however be an important trend as we move into 2023.
There’s also been noteworthy stress in other areas. Japan’s ultra-low interest rate versus the US caused the Yen to slide to a 24-year low, causing the Bank of Japan to intervene in the currency market. While in the UK, mini-budget aftermath caused large bond price moves.
WHAT DOES THIS MEAN FOR INVESTMENTS WITH COUTTS?
Coutts made three notable changes within client portfolios and funds over the past month to reflect current conditions.
- A new holding in high quality investment grade bonds was introduced – yields for these bonds tend to be less sensitive to interest rate movements and could offer an attractive opportunity after recent volatility in credit markets.
- US government bond holdings were increased given higher yields. US Treasuries seem exclusively focused on Fed guidance while seemingly ignoring the economic slowdown coming in 2023, which should lead to lower yields. Coutts will be keeping an eye on this though as thoughts are that could change next year.
- Allocation to Japanese government bonds has been reduced due to interest rate uncertainty.
Coutts have also sold Chinese equities and switched into developed market equities. The recent Communist Party Congress appeared to de-prioritise an economy already growing less than expected due to Covid-related lockdowns.
THIS MONTH’S SPOTLIGHT:
SUNAK’S BIG CHALLENGE
Rishi Sunak’s appointment as Prime Minister should help restore some credibility back to the UK and see its government and central bank pull in the same direction. Both those things should bring much-needed stability back for investors.
Sunak has big challenges ahead of him though. He needs to cut public spending by around £30-£40 billion a year to help close the country’s budget deficit, which is around £70 billion according to the Office for Budget Responsibility.
How he does it will likely be unpopular, particularly amid a cost of living crisis and rising interest rates, with the Bank of England recently hiking them to 3%. The government may try to push any measures into the future, but the UK outlook for 2023 remains difficult given spending cuts, a likely recession and elevated inflation.