The challenges we’ve been seeing in financial markets throughout the first part of 2022 certainly didn’t abate in the month of April and into the early part of May.
Official Cash Rates Increasing
The key driver of these challenges has just been the ongoing rise in inflationary pressures that we’ve seen both domestically and globally. This has resulted in Central Bank’s increasing official cash rates. Domestically this has meant that for the first time in over a decade, the RBA increased the official cash rate, lifting it by 25 basis points to 35 basis points. The US Federal Reserve has increased its official cash rate by 1% over its last two recent meetings.
As a result of rates rising across the world there has been a significant sell off in fixed income assets, particularly sovereign bonds, and we’ve seen Australia’s 10-year bond rate increase by close to 150 basis points or 1.5% over the last three-month period. We’re now seeing a 10-year bond rate well north of 3%, closer to 3.5%.
Higher Inflationary Pressures Impacting Commodity Prices
The implications for financial markets on the higher inflationary pressures coming through the system are significant, and we believe that this will continue throughout the remainder of 2022 into 2023. This has been compounded by drivers such as the war in Ukraine and the Covid zero policy in China. This is having a significant negative impact on supply chains and commodity prices, from energy right through agricultural goods.
China’s COVID Zero Policy
The Covid zero policy adopted by the Chinese government is having a strong negative impact on China’s industrial capacity and by consequence implications for the supply of goods right around the world as China is the heartbeat of the World’s industrial manufacturing capabilities.
The fact that we are starting to see areas such as Shanghai in lockdown is having a significant negative impact on supply of goods and services combined with the logistic challenges that we have been experiencing over the last 12 months show no signs of abating in the near term.
This is also happening in the backdrop where the unemployment rate has continued to moderate globally, which is creating further challenges associated with increasing wage pressures that is further impacting the inflationary outlook.
Ongoing Implications in 2023
In our view there are several interrelated factors that are clearly driving financial markets at present, with rising inflation at the core. Inflation, domestically is now above 5% above 7.5% in the US. Central banks are focused on driving it lower, which will only result in further increases in official cash rates as we head though the course of this year into 2023. When combined with a demand profile that continues to remain elevated, we believe inflationary pressures are going to continue to be challenging and remain higher for longer throughout the second part of this year. This will continue to challenge investment markets and we need to be mindful of adopting as flexible approach as we can to manage both risk and the investment opportunities that may present as we move forward.
Piers Bolger is Chief Financial Officer at Viridian Advisory.
Visit our website: www.infinityassetmanagement.com.au
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