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Article | 15 December 2022 | Investments
Mounting hopes of a pivot in interest rate policy continued to drive the markets. Fed chair Jay Powell suggested that the phase of ‘jumbo’ hikes could soon be over, with the latest hike in rates at only 50 basis points. Nonetheless, the ‘higher for longer’ message on interest rates was reinforced. Recession forecasts hung in the air, as the US government bond yield curve reached its most inverted point since 1981. The price of oil slipped to the year’s low on demand concerns, until the apparent ending of the China’s zero-Covid brought a rally. US and eurozone inflation fell short of forecasts, briefly boosting sentiment, before unexpected strength in US jobs and services data prompted a rethink.
Global stocks rose strongly in November, marking the first back-to-back monthly increase since mid-2021, with Chinese markets leading the pack. Global bonds also rose on hopes that inflation might have peaked, with the 10-year US Treasury bond returning 3.7% in November alone. Emerging market bonds outperformed, as the dollar slipped further. Dollar weakness was prompted by expectations that the Fed would start to scale back the pace of rate hikes. Meanwhile, the Japanese yen rose strongly after the Bank of Japan hinted at changes to policy targets.
Following recent positive developments on the inflation front and for central bank monetary policy, the backdrop for equities has become less negative. Inflation dynamics appear to be on an improving trend, which is allowing the US Federal Reserve to dial down the hawkish tone they have maintained for much of the year. Markets have responded very favourably to these developments and sentiment remains reasonably buoyant heading into year end.
Markets may yet pose their owns issues in 2023, meaning our preference is to reduce relative risk into year end, before reassessing our outlook early in the new year. With this in mind, we are more positive on European equities and indeed equity markets overall.
We are very optimistic on investment grade fixed income, due to the improving inflation picture and the likelihood of a more stable period for bond yields in the near term. Given the more benign outlook, we believe the additional yield offered by investment grade bonds can now be earned with a lower risk of capital losses, as spreads over government bond yields could remain reasonably stable.
However, we remain cautious on government bonds, especially European government bonds, which we still see as unattractive.