May Market Update with Piers Bolger

May Market Update with Piers Bolger 150 150 Piers Bolger

Ongoing Inflationary Pressures Driving Markets Down

May proved to be another difficult month for financial markets as we saw both equity and bond markets weaker over the month. We believe that the real driver was the ongoing rise in inflationary expectations, which continues to permeate on a global basis, as well as the changing stance from central banks.

Central Banks

Central banks are becoming a lot more aggressive with their monetary policy framework, whether it be in developed or emerging market economies. Domestically, we saw the RBA increase cash rates by 0.25% in May. This was followed up with a further 0.5% rise in early June, meaning the cash rate now sits at 0.85% (85 basis points).

We continue to expect cash rates to move higher over the next 6-12 months, given the fact that inflationary expectations are well north of central bank target bands. Domestically, we see the cash rate somewhere in the range of 2.25% -2.5% by June of next year. And we think that inflation is likely to peak north of 6% domestically, which will continue to be a challenge for the policymakers over that period.

Drivers Of Inflation

Macro and geopolitical events continue to drive inflation as opposed to just domestic related issues. In the context of commodity markets, the war in Ukraine is having a significant negative impact on the supply of agricultural goods into global markets. Restrictions on Russian oil and gas is also having a powerful impact right across the globe, particularly in Western Europe who heavily rely on these Russian resources.

Covid Zero Policy In China

The Covid zero policy in China is also having implications for industrial manufacturing and the supply of goods into the global economy. Due to continued lockdowns, we’ve seen a significant negative impact on the growth outlook for China.  We believe this policy continues to restrict global supply chains, with increased inventory build up by companies leading to higher prices.

Supply Chain Issues Continue

Ongoing demand for goods remains high with the lack of supply continuing to drive up prices. Labour mobility also continues to remain relatively constrained, being nowhere near as flexible as it was pre Covid. This is an issue that we’re seeing across multiple sectors of the economy. This has resulted in wages moving higher in parts of the economy both domestically, as well as on a global basis which is flowing through to inflationary expectations.

The challenges that we see for central banks in the medium term is how do they try and contain inflationary expectations, or at least start to moderate it without tipping individual economies into recession. This is probably the biggest issue facing policymakers over the next 6-12 months, as where there are a lot of exogenous and macro factors that aren’t necessarily in their direct control that are driving inflationary pressures.

Portfolio Positioning

Given this backdrop we remain focused on mitigating downside risk across portfolios understanding that both growth and defensive assets are generating negative returns at present.

In the context of individual strategies, we’re continuing to remain underweight duration within our fixed income exposure. Although, within our fixed income allocations, we’re focused on direct individual investments.  We have also increased the exposure to real assets that provides some protection to rising inflation as well as our allocation to alternatives as a means of balancing the (equity and bond market) risks across our portfolios.

Piers Bolger is Chief Financial Officer at Viridian Advisory.

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