Page 54 - DIY Investor Magazine | Issue 33
P. 54

  With global markets close to post-Ukraine war highs, we remain neutral on global equities.
There seems limited scope for further upward gains in the short term in an environment of increasingly hawkish rhetoric from the US Federal Reserve and ECB while valuations for US equities which account for approximately 50% of global market capitalisation remain well above long-run average levels – writes Alastair George
This hawkish turn in central bank policy is something of
a surprise to us, given the resolutely dovish bias of both institutions over the past decade. However, with at least one US rate increase now expected at each FOMC meeting for the rest of the year, the US Fed is serious about tightening financial conditions to squeeze out inflation.
In the UK, the Bank of England is the outlier for now, raising interest rates by a further 0.25% but alluding to the possibility of an easier trajectory of rate increases as growth slows due to the economic impact of the war in Ukraine.
Both the US Fed and ECB are now in something of a self- imposed catch-up mode, having spent much of the prior 12 months asserting that the surge in inflation was transitory.
Yet the “transitory” inflation argument has been cast aside during Q122. In his most recent press comments, Fed Chair Powell highlighted his determination act “expeditiously” to tighten policy to avoid embedding higher inflation expectations within the economy. The recent war-induced rise in energy and food prices is clearly unhelpful for the Fed’s objective. Headline inflation will be higher and above central bank targets for longer, compared to expectations at the start of 2022.
Following this turn in central bank policy long-term government bond yields have been rising rapidly, Exhibit 1. Despite the outbreak of war in Ukraine, which would normally be expected to be positive for government bonds as investors seek safe havens, the pace of increases in global bond yields has only accelerated. We note the US 10y yield is now above levels prevailing in the pre-COVID era.
   Yet the implicit forward guidance in the dot-plots contained within the US Fed’s Summary of Economic Projections (SEP) that US rates will rise monotonically from current rates for the remainder of the year is only part of the story, in our view.
Judging from the yield curve, Exhibit 2, investors do not expect the US Fed to be able to raise rates as quickly as policymakers currently indicate and we would concur with this assessment. The recent increase in food and energy costs worldwide
is likely to act as a significant drag on consumer-driven economies.
Developed market GDP growth was in any case set to decline during H222 as COVID-19 base effects fell out of the data.
We note the spread between US 2-year and 10-year rates is already close to zero, leaving the yield curve perilously close to inversion, which often signals a recession ahead.
The combination of rapidly rising interest rates and a slowing economy at a time of surging energy and food prices is hardly an ideal environment for equities, in our view.
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