MONTHLY UPDATE: When will the big interest rate hikes end?

WHAT’S HAPPENING IN FINANCIAL MARKETS?

Every inflation announcement this year has been a big day for investors. We actually think they should be looking at company earnings instead, but for most inflation remains the big focus.

When US inflation data came out in October we saw an interesting turnaround. Inflation came in hotter than expected and the country’s stock markets swooned, but they soon recovered and rallied.

Coutts Head of Investment Strategy Sven Balzer said: “Markets know the Fed (US Federal Reserve) can’t continue hiking at the current 0.75% pace forever. That pace has to slow.

“At its November meeting the Fed alluded to this ‘peak of pace’. Of course, current US inflation of 8% is not a number it can live with. But the US housing market is at a standstill, commodity prices have fallen and company inventories are rising while demand drops. So looking into 2023, a slowing economy and declining business activity should gradually negate the need for big rate hikes.”  

Another reason stock markets recovered was that the Q3 company earnings season, although weak, was no worse than expected. Weaker earnings will however be an important trend as we move into 2023.

We’ve also seen noteworthy stress in other areas. Japan’s ultra-low interest rate versus the US saw the Yen to slide to a 24-year low, causing the Bank of Japan to intervene in the currency market. While in the UK, the mini-budget aftermath caused large bond price moves.

WHAT DOES THIS MEAN FOR YOUR INVESTMENTS?

We made three notable changes within our client portfolios and funds over the past month to reflect current conditions.

• We introduced a new holding in high quality investment grade bonds – yields for these bonds tend to be less sensitive to interest rate movements and could offer an attractive opportunity after recent volatility in credit markets.
• We added slightly to our US government bond holdings given higher yields. US Treasuries seem exclusively focused on Fed guidance while seemingly ignoring the economic slowdown coming in 2023, which should lead to lower yields. We’ll be keeping an eye on this though as we think that could change next year.
• We reduced our allocation to Japanese government bonds due to interest rate uncertainty.

We’ve also just sold Chinese equities and switched into developed market equities. The recent Communist Party Congress appeared to de-prioritise an economy already growing less than expected due to Covid-related lockdowns.