The US Federal Reserve
The US Federal Reserve began its rate tightening program and increased official cash rates by 25 basis points (0.25%) to take the Federal Funds Reserve rate down to 0.50%. We expect the Fed to increase official cash 50 basis points (0.50%) at its next meeting in May, given the fact that inflation in the US is running well north of 7%.
Commodity prices continue to increase. Oil and natural gas oil went up over 10% over the course of the month, with natural gas up 28%. A lot of the increase was driven by the war in Ukraine, as well as the challenges around the energy supply, particularly for Western Europe.
We saw a significant divergence in the ASX 200 index (compared to global markets), with it up over 6.5% during the month of March. This was predominantly driven by higher commodity prices feeding through into the performance of the energy and materials sector.
As well as the selloff in the local bond market, the 10yr bond yield was up over 70 basis points for the month. This saw the local bond market decline by over 3.5%. The variance between the bond market and the equity market was over 10.5% in March alone.
Bond yields are also up 200 basis points since the low point of the last few years. When we have periods where bond yields move significantly higher, this has a large negative impact on the performance of the broader market due to the duration of the index.
Remaining Underweight in Bonds
The sheer size of the movement in bonds is one of the reasons why we have remained underweight in bonds within our portfolios for some time now. Given that bond yields were too low, we felt that we would start to see some level of central bank tightening which would lead to some normalisation of the yield curve. This has been driven by higher commodity prices, which has pushed up inflation, particularly around the supply and demand imbalances.
Whilst bond markets are currently looking a little bit better value, we’re not of the view that they’re outright cheap. The switch between equities and bonds is still a while off because we do expect that bond yields are going to continue to move higher as central banks start to normalise and increase official cash rates. We don’t believe all of the future rate tightening is currently priced into the market.
We expect inflation to start to moderate in terms of year-on-year prints through the second half of 2022. We think this will provide some opportunity for bond markets to start to appreciate, which will provide some opportunities to increase our asset allocation to the sector, particularly with yields up over 3%. We expect that we’ll get to that figure throughout the course of 2022 at both a domestic and global scale, particularly in the US.
Well-Diversified and Well Thought Approach Needed
Overall, it’s been an interesting and challenging market throughout March. The variance between equities and bonds at over 10.5% was significant, and the largest monthly divergence I’ve seen over the last decade. This points to some of the challenges that are clearly still very prevalent across financial markets and demonstrates how important it is to have a well-diversified and well thought out portfolio that can look to manage both equity and bond risk.
Piers Bolger is Chief Financial Officer at Viridian Advisory.
Visit our website: www.infinityassetmanagement.com.au
This post and some supporting materials may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice we may have given you, having regard to your own objectives, financial situation and needs before acting on it. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product. The material in this post is correct and complete as of the date it was posted. Viridian is not responsible for, and expressly disclaims all liability for, damages of any kind arising out of use, reference to, or reliance on any information contained within this site.