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Article | 10 February 2023 | Investments
Chief Investment Officer
Inflation readings continued on a downward path, with the US and Europe as stand out examples. Nonetheless, western central banks maintained their hawkish rhetoric, with the European Central Bank in particular keen to forecast further interest rate hikes ‘at a stable pace’. The prospect of recession in major economies faded, with a soft landing seen as more likely following a jump in US employment numbers and broadly improving PMI data. The International Monetary Fund raised its growth outlook for 2023 and beyond, citing China’s zero-Covid pivot, US support for green investment and lower recessionary risk in Europe as reasons for the improved forecast.
Global equity markets rallied strongly, boosted by optimism over China’s reopening. Global bonds also rose, as a further decline in inflationary pressures boosted hopes that central banks might rein in the pace of interest rate hikes. The 10 year US Treasury bond gained 3.1%, while the 10 year German Bund returned 2.5% over January. The US dollar weakened as investors factored in a possible end to the US rate hiking cycle. Natural gas prices fell sharply to levels last seen prior to Russia’s invasion of Ukraine, helped by unusually mild European weather. Industrial metals rallied in anticipation of stronger demand from China.
Markets have continued in reasonably buoyant mood, driven by a combination of improving inflation dynamics and an increasing belief that central bank policy will result in a softer landing, thereby avoiding recession. That said, double digit gains from many markets so far this year could leave them exposed to pullbacks on any disappointing news. Our preference would be to add further to equities in the event of any meaningful correction, so we maintain a neutral allocation to equities in the near term.
Within equities we continue to favour Asia ex-Japan and the Emerging Markets. Following the reopening of the Chinese economy, we believe that economic activity will continue to increase, bringing the region a period of relative outperformance. We remain relatively less positive on US equities, which no longer have the supportive tailwind of a strong US dollar. In a continuing environment of elevated inflation and higher bond yields, the growth bias of the S&P 500 could weigh on overall performance.
With regard to fixed income, we would expect bond yields to remain reasonably range bound in the near term. While yields could well rise sporadically on hawkish central bank rhetoric, we don’t foresee any repeat of the large moves experienced in 2022. We maintain our preference for both emerging market debt and investment grade credit. Credit spreads over government bonds remain attractive here, and we continue to like the higher interest rate levels on offer in both asset classes.