Market update   

Investors’ attention was primarily focused on the US Federal Reserve’s interest rate decision over the month of June. In line with market expectations, the Federal Open Market Committee unanimously voted to keep the federal funds target range unchanged at 5% - 5.25%. The official press release statement and conference both focused on requiring the time to assess the incoming data and its resultant impact of the Fed’s economic outlook. Interestingly, there were some noteworthy revisions made to the Fed’s economic projections. In line with better-than-expected economic data recently, real GDP projections were lifted to 1% this year from 0.4% while personal consumption expenditure (PCE) inflation forecasts were little changed at 3.2% from 3.3% previously forecast. Importantly, however, core PCE forecasts were lifted to 3.9% in 2023 from 3.6% previously estimated, once again highlighting the broad-based nature of inflationary pressures. This remains evident in the mind of committee members as evidenced by an even higher forecasted trajectory of the federal funds rate in the coming years. Accordingly, we remain of the belief that the Fed will indeed keep the policy rate higher for longer until inflationary pressures firmly dissipate, and labour market weakness emerges.   

It is worth noting that we remain concerned over the credit-fuelled spending by the US consumer to prop up short-term expenditure prospects. Moreover, the confirmation of the reactivation of student debt payments in October this year amassing to $1.6 trillion will likely be a headwind to future earnings prospects, however, President Biden is currently renewing his efforts under a different law to waive these outstanding loans. Nevertheless, a potential drain of the liquidity impulse in the second half of the year may also weigh on valuation multiples - particularly for overvalued stocks - hence our defensive positioning at this juncture. 

In emerging markets, it is certainly encouraging to see the People’s Bank of China ease monetary policy conditions further by slashing several different interest rates over the month. However, weakness in coincident to lagging economic data, particularly sluggish consumption expenditure amid pre-payment of mortgages by locals highlights a potential confidence issue in the broader economy. With low levels of inflation levels and notable excess savings combined with attractive valuation multiplies, we are of the belief that selected opportunities remain in the Chinese economy and will be on the lookout for more palatable policy responses from fiscal authorities. 

In one of the most unprecedent monetary policy moves in history, the Bank of Japan continues to inject an ample amount of liquidity through bond purchases in the economy resulting in the Nikkei 225 climbing 7.6% in June bringing the year-to-date gain to 28.7%. Conversely, in the UK, the Bank of England surprised market participants by hiking the bank rate by 50bps to 5% over the month to quell broad-based inflationary pressures. Similarly, the Eurozone Central Bank remain on a tightening path and lifted the refinancing rate by 25bps to 4% over the month amid untenably high inflation.    

Going forward, we remain of the view that global liquidity injections continue to mask asset price discovery. We are closely monitoring the resultant impact on any perverse effects of a reduction in global liquidity in the coming months given the need to replenish the US treasury general account. Moreover, political risks remain high as evidenced through the Wagner Group rebellion in Russia. Accordingly, we believe that selected opportunities will emerge with better entry points.     

Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in consumer behavioural patterns. Higher borrowing costs for both businesses and consumers will likely supress economic activity, particularly in discretionary related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. Households are utilising various credit instruments, particularly credit card debt which is currently at all-time highs to prop up short term expenditure prospects. Moreover, the reactivation of over $1.6 trillion of student debt in October may well present a headwind to future earnings prospects if President Biden does not succeed in waiving these outstanding loans under a different law. Accordingly, we remain of the view that economic growth and company earnings expectations are currently too optimistic. Nevertheless, if liquidity remains plentiful, this may prevent price discovery from emerging in the short-term. 

We believe that the China re-opening will support the economy and that the equity market standards to benefit barring any further haphazard policy pronouncements. However, the recent slowing of coincident to lagging economic data has disappointed relative to investors’ expectations. Nevertheless, the mobility and credit impulse data continue to improve and highlight that a potential recovery, albeit fragile at this juncture, is still on the horizon and presents selected opportunities.  

On the fixed income side, once peak hawkishness of the Fed has been sufficiently priced in by market participants, labour market weakness emerges and inflation is firmly on a downward trajectory, we will be looking to take a more explicit position on the long end of the curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears. For now, T-bills remain attractive with a higher yield offering compared to most sovereign bond curves without taking on too much duration risk. 

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