September was another difficult month for financial markets. Ongoing official cash rate rises combined with sticky inflationary data, moderating economic growth and a difficult geopolitical backdrop resulted in a big selloff in both equity and bond markets as investors sought the safe haven of the US$, which had one of its strongest periods ever over the month, and was up over 6.5% v’s the AUD.
Cash Rates Rise
Over the month the US Federal Reserve and ECB both raised official cash rates by 0.75%, while the RBA increased cash rates by a further 0.50%, taking the official cash rate to 2.35%. (As at the time of writing this report, the RBA has increased cash rates by a further 0.25% to 2.60%. This is an increase of 2.50% since April). We expect that the domestic cash rate will be 2.85% by CY22, with a forecast terminal rate at 3.50% by mid-2023.
The move by central banks and the hawkish approach to future cash rate rises, particularly by the US Fed, which continue to view the current policy setting as accommodative, resulted in a major sell off government bonds. Yields at the short end of the curve rose rapidly, and with further rates likely the probability of a global recession through 2023 has increased in our view. While the US Fed has been aggressive in raising rates, the BoJ has been steadfast in making no change to its monetary policy despite inflation at 2.8% (y/y), its highest since 2014.
GBP and USD
In addition, the GBP flirted with parity to the USD as the revised budget of the new Truss UK government was viewed poorly by financial markets. It is clear the UK economy is in disarray and has been made worse by the state of politics in the country. The move in UK Gilts over the month has put further pressure on the BoE as it seeks to calm financial markets.
Chinese Economy Continues to Stagnate
The Chinese renminbi also came under pressure over the month dipping below 7.0 to the USD for the first time since July 2020. The Chinese economy continues to stagnate, hampered by rolling Covid lockdowns and a widening failure of the property market. While the Chinese authorities have sufficient means to salvage the property sector, given it is a key driver of economic activity, its failing is further impinging on an already weak outlook for the country. With President Xi Jining seeking a third term at the upcoming People’s Party Congress in October, the failings of the property sector and disenchantment by many homeowners creates a level of risk to Xi’s power base in our view.
Russia and Ukraine Conflict
In Eastern Europe, the War continues to go from bad to worse for Russia. Ukrainian forces have recaptured significant swathes of occupied land as Russian forces have hastily retreated post a successful Ukrainian counteroffensive. However, with the likelihood of Russia ramping up its military operations, the risks continue to increase with the near-term hope of any peace talks slim.
Against this backdrop, our asset allocation positioning remains focused on managing downside risk. The thematic focus that we continue to consider at a portfolio level remain focused on two key aspects:
1) Maintaining an investment allocation that is suited to higher inflationary pressures (in conjunction with higher cash rates and stronger US$). We continue to play this exposure through the overweight positions in alternatives as well as property & infrastructure, inclusive of real assets, while being underweight our neutral position to the A$.
2) At the same time, maintaining a broad-based investment strategy across the core equity and bond positions. We believe this to be important as it can provide further diversification and downside protection into the portfolios. To this end, our equity position remains neutral at a headline level, although we continue to maintain an overweight exposure to broad equity exposures (domestic and global) over small caps as well as emerging markets (for global). The need to adopt a flexible investment and asset allocation framework remains appropriate.
Piers Bolger is Chief Investment Officer of Viridian Financial Group.
Visit our website: www.infinityassetmanagement.com.au
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