- The Federal Open Market Committee (FOMC) opted to keep the federal funds target range unchanged at 5.25% - 5.5%.
- The higher for longer mantra was firmly revealed in the US Federal Reserve’s outlook as policy rate projections were lifted for this year and next in increments of 50bps each relative to June projections.
- China displayed some better-than-anticipated data releases as aggregate financing, industrial production, and retail sales all improved.
- The recent reacceleration in energy prices amid OPEC supply cuts combined with ample liquidity may well complicate the inflation trajectory from here.
Monetary policy decisions from major global central banks were in focus over the month, chief among them – the US Federal Reserve.
In line with market expectations, the Federal Open Market Committee (FOMC) opted to keep the federal funds target range unchanged at 5.25% - 5.5%, however, some notable changes took place in the committee’s projection material. While it is certainly encouraging that economic growth forecasts were lifted with a corresponding decrease in unemployment projections, the primary message remains firmly centred on where the federal funds rate is heading. Unsurprisingly, the higher for longer mantra was firmly revealed in the central bank’s outlook as policy rate projections were lifted over the next two years in increments of 50bps each relative to June projections. This comes on the back of a re-acceleration in the latest August CPI print to 3.7% year-on-year from 3.2% the previous month. It is worth noting that inflation index levels for the fourth quarter of 2022 will make it much easier for inflation prints to be higher year-on-year as we head into the close of the year. Moreover, recent survey data suggests inflationary pressures are re-emerging. This combined with a recent reacceleration in energy prices amid OPEC supply cuts may well complicate the inflation trajectory from here. This reiterates the need for the Fed and US Treasury to drain liquidity from financial markets in order to quell price pressures even further.
The Bank of England also paused at their latest committee meeting keeping the bank rate at 5.25% on the back of slowing inflation dynamics. However, inflation remains untenably high last registering a print of 6.7% year-on-year in August. While the Bank of Japan also stood pat keeping their policy rate at -0.1%, the new Governor - Kazuo Ueda - has recently hinted at removing their negative interest rate policy, particularly if wages accelerate meaningfully in the coming months. The European Central Bank continued on their hiking cycle lifting the refinancing rate by another 25bps to 4.5%. Importantly, the central bank’s forecasts for inflation were lifted for this year and next relative to previous projections, which will likely result in a continued restrictive monetary policy stance from here.
In emerging markets, China displayed some better-than-anticipated data releases as aggregate financing, industrial production, and retail sales all improved. Moreover, the People’s Bank of China opted to cut the reserve requirement ratio by 0.25ppts which should free up liquidity for banks to be able to increase the amount of lending taking place in order to stimulate the economy. Overall, valuations continue to be cheap, and the economy continues to recover, albeit at a subdued pace.
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. Accordingly, we believe there are 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 compared to most sovereign bond curves without taking on too much duration risk.
The USD Global Growth and Balanced Fund fell 3.7%1 and 3.1% each compared to their Morningstar peer groups which registered a downturn of 3% and 2.7% respectively. The retracement can largely be ascribed to a 5.7% 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 an alternative long-short fund position, energy and commodity allocation, as well as dollar cash position added value over the month. Our most defensive fund with the highest fixed income structure, the Sterling Asset Management Fund, fell 2.6%.
1 Performance stated in the I share class