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Article | 20 September 2022 | Investments
US inflation data ticked lower at the headline level, although rising core inflation pushed back any hopes of a ‘Fed pivot’ on interest rates. Indeed, rhetoric from the US Federal Reserve (Fed) remained resolutely hawkish, with inflation control still the top priority. The European Central Bank (ECB) joined the Fed and the Bank of Canada in the ’75 basis points club’ with regards to interest rate hikes. The US economy posted a second consecutive quarter of negative growth, while forecasts for German growth were cut sharply in the face of an ‘economic avalanche’. Natural gas prices in Europe soared again, as the Nord Stream 1 pipeline from Russia was closed indefinitely, whereas sharp falls in the oil price prompted talk of further OPEC+ production cuts.
Bouts of volatility returned to financial markets, in response to hawkish commentary from the Fed. Government bond yields began to rise sharply in late August, as prices fell. Growth stocks were battered, losing part of the ground made up over the summer, even as materials stocks suffered from falling demand expectations. Meanwhile the US dollar maintained its positive trend for a third successive month, breaking through parity with the euro, touching twenty year highs against the Japanese yen and approaching the key Rmb7 level against the Chinese renminbi.
We remain concerned over equity markets, believing that the key issues of elevated inflation and higher interest rates will continue to weigh on sentiment near term. We maintain our preference for US and Asia Pacific relative to European equities, where we have adopted a fully negative stance in anticipation of a bleak winter ahead. We have dialled back our preference for China and Asia ex Japan, awaiting further clarity on policy from the Communist Party Congress in the autumn.
In terms of equity portfolio construction, we maintain a style neutral approach, leaning towards defensive tilts, such as quality and low risk options. A protracted period of higher bond yields presents a headwind for the growth style, while the possibility of a global recession could also bring headwinds for value and cyclical stocks.
With regard to bonds, we are looking to take profits from our position in US government bonds, although we do not expect further large downside moves near term. We remain negative on European government bonds, believing the European Central Bank to be ‘behind the curve’ on interest rates. We continue to see value in investment grade credit, taking advantage of the additional yield offered by this asset class over government bonds.
Elsewhere, we are still positive on cash, although would prefer fund managers to seek more attractive returns from lower risk sectors such as short-dated investment grade and high yield corporate bonds.