August was certainly an eventful month amid a flurry of data releases and some surprise events.
At the beginning of the month, Credit Rating Agency, Fitch, downgraded their US sovereign credit rating from AAA to AA+ citing concerns over a deterioration of the government’s debt burden. While this is now in line with S&P’s credit rating, it is somewhat concerning that the US Treasury has opted to issue a hefty amount of T-bills more recently at a higher funding cost relative to more long-dated debt.
On the inflation front, US CPI re-accelerated to 3.2% year-on-year in July from 3% in the previous month, although core inflation, excluding volatile food and energy items, remains untenably high at 4.7%. Accordingly, it is unsurprising that Fed Chair, Jerome Powell, reiterated the need for the world’s most influential central bank to keep the federal funds rate higher for longer at Jackson Hole. Powell did acknowledge that they cannot identify the neutral rate - the interest rate that is neither stimulative of restrictive - with certainty. However, he did state that if above-trend growth emerges, further tightening could be warranted despite positive real rates which are above current neutral estimates. Powell also quashed ideas that the Fed would change their 2% inflation target.
Financial conditions have loosened materially since October last year amid Fed interventionism in the banking sector, drawing down the treasury general account and with the US National Secretary, Janet Yellen’s, more recent selective fiscal issuance on short-dated debt. The latter has prevented liquidity from being drained materially as this incentivizes reverse repo users to buy T-bills leaving liquidity dynamics relatively stable. These decisions may prevent inflation from falling back towards the 2% target in a sustainable manner, particularly as favourable base effects for inflation will dissipate in the coming months. Accordingly, interest rate re-pricing in bonds remains a risk in developed markets as the ECB, BoE and the Fed all remain committed to tightening at this juncture.
In Asia, Japan GDP printed at an annualised pace of 6% in the second quarter, surpassing Bloomberg expectations of 2.9%, highlighting that the economy remains on a solid footing. Conversely, to reinvigorate the Chinese economy, authorities eased mortgage rules, reduced stamp duties on stock trading, tightened initial public offerings by requiring proceeds to be spent on main businesses, slashed the foreign exchange reserve requirement ratio among other measures.
In our view, liquidity remains ample and will need to be drained to realistically achieve a 2% inflation outcome in developed markets. Moreover, we will likely need to see tightness in the labour market dissipate which from a monetary policy perspective should lead to real rates remaining positive into next year.
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. 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 stands 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, we believe there are still selected opportunities on the horizon, particularly with recent stimulus announcements, and will be cautious with our asset allocation sizing.
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.
The USD Global Growth and Balanced Fund fell 2.5%1 and 1.7% respectively compared to their Morningstar peer groups which registered a downturn of 2.1% and 1.6% respectively. The retracement can largely be ascribed to a 4.6% contraction in our newly launched Global Equity Growth Fund. Nevertheless, this equity allocation has a strong track record being run as a segregated mandate for many years and volatility is expected month-to-month. However, our relatively low allocation to fixed-income, notable sizing toward our alternative long-short fund position and dollar cash position added value over the month. Our most defensive fund with the highest fixed income structure, the Sterling Asset Management Fund, fell 1.2%.
1 Performance stated in the I share class
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