Investment Comment
9th June 2023
It Ain’t Over ‘Til It’s Over
The ‘Fed Pivot’ has been a strong theme of recent months with many believing that we had reached the peak of the interest rate cycle (at least in the US) and so we could look forward to rate cuts later in the year providing a fillip to markets. However, these hopes are set to be dashed, at least in the short-term.
This week brought two ill-winds from Canada. Firstly, smoke from a particularly intense wildfire season has spread south into the US, and recalling the worst days of the pandemic, mask-wearing for public health has returned.1
Second, the Bank of Canada (BoC), which was the first and only G7 central bank to pause its tightening campaign, has now abandoned that position succumbing to pressures from stronger-than-expected economic momentum and stubbornly high inflation. The BoC raised its interest rate by 0.25% to 4.75%, a move that surprised markets. The Reserve Bank of Australia also had to resume rate hikes this week and we believe that this sets a precedent for other central banks as it becomes clear that further rate rises may be necessary to restore price stability. It’s also a reminder that even after interest rates peak, rate cuts may not follow quickly thereafter.
In the US, next week sees the next inflation release, quickly followed by a meeting of the Federal Reserve. Markets are currently pricing no change of interest rates this month but that tightening may resume in July following strong employment data, which highlights ongoing strength in labour demand, albeit other economic releases have been mixed. If inflation numbers come in worse than expected next week, it would be no surprise to see another interest rate hike. Bond yields have been rising (and so bond prices falling) over recent weeks as investors price in these expectations. The other big news in the US was agreement over the debt ceiling, where Republicans seem to have backed off despite gaining very little in spending cuts (it seems spending rises are in vogue on whichever political wing you sit right now) and so the longer term issue of debt sustainability is kicked down the road for at least 2 more years and until Congress is once again divided on the issue (highly likely if President Biden wins re-election). In the short-term, this along with the continued strength in employment data and confidence that inflation is moderating seems to have boosted equity markets and we’ve seen broad based gains so far in June. We’ve talked previously of how the market has bifurcated this year, with market gains driven almost exclusively by big tech names (in part boosted by a degree of AI-hype) and it has been welcome to see the rest of the index catching up. Whether this broader confidence is justified will depend on whether the economy can achieve a “soft-landing” and avoid a recession despite the scale of policy tightening that we have seen. While historic precedents suggest that bringing inflation down from such high levels without a recession is unlikely, the ongoing aftershocks from the Covid Pandemic make this much harder to call.
On the subject of recessions, downward revisions to Q1 GDP data mean that the eurozone economy has recorded two consecutive quarters of -0.1% growth and so is technically in a recession. After better-than-expected economic numbers through the winter, as the energy shock was less extreme than expected (supporting strong performance from European assets), more recent data has been soft, particularly in Germany. The European Central Bank also meets next week and, while another interest rate rise is expected, it seems likely that we are close to the peak as economic data softens.
And finally to the UK, where stubbornly high inflation means markets expect another 4 interest rate hikes from the Bank of England (BoE), increasing the base rate by 1% by the end of the year. It is a distinctly more hawkish view than for other central banks and we are sceptical whether the BoE is prepared to inflict that level of pain on a struggling economy. As interest rate expectations grind higher so too do mortgage rates and, as I write this, banks are pulling mortgage deals with a view to repricing higher. This all adds to pressure on the consumer. As and when people need to refinance debt, they can expect another chunk of cash to be taken from their disposable income. While economists don’t currently forecast a recession, economic growth remains stubbornly low and inflation stubbornly high. Policy answers are not exactly forthcoming but from an investment perspective increased bond yields are providing attractive opportunities within fixed income that we haven’t seen for a long time, and on the equity side, we retain a small allocation to the UK with the bulk of equity exposure globally diversified.
Gareth Thomas Head of Investment Management
1 While you can never claim an individual instance like this is driven by climate change, increased temperatures and more extreme weather conditions, increases the likelihood of such events. While this note I focused on short-to-medium term investment conditions, please read our note on Our approach to climate that discusses the climate impact of investment portfolios and what you can do to mitigate.
All expressions of opinion reflect the judgment of Artorius at 9th June 2023 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions. Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.
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