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On the road again

market snapshot

9 June 2023 |
In a week where both the Bank of Canada (BoC) and the Reserve Bank of Australia (RBoA) surprised markets by resuming their monetary tightening, investors asked the question: are we back on the path of higher for longer?
  • The RBoA raised rates by increasing its cash rate target by 25bps to 4.10%, the highest level since 2012.
  • The BoC raised rates for the first time since January – raising the case rate by 25bps to 4.75%.
  • Yields on US 10-year Treasuries rose 2.75% over the course of the week bringing the one-year change to +22.72%. The S&P500 climbed 2.73% over the week, helped by investor interest in AI-influenced stocks.1 

It was a will-they-won’t-they kind of a week for central bank watchers as both Australia and Canada defied expectations to resume their hiking cycles. A rise in US jobless claims tempered fears that the US Federal Reserve would follow suit – nonetheless, with upcoming meetings for the Fed, the European Central Bank, the Bank of Japan and the Bank of England, investors face renewed uncertainty over the future course of monetary policy.

Orla Garvey, Senior Fixed Income Portfolio Manager at Federated Hermes Limited, noted that the Fed is widely expected to pause at next week’s FOMC meeting before resuming hikes in July and September, but that there is still some potential for a surprise.

“Our view is that we’re coming towards the end of the current hiking cycles and, while further hikes are possible, the bigger and more impactful call is how long central banks remain at terminal rates and then when and by how much they will cut as economies begin to slow,” she said.

Even so, she highlighted how unique the current cycle is given the scope for entering a global downturn even as inflation remains sticky. “Higher-than-desirable core inflation limits the amount of relief that can come from rate cuts in the short term,” she said. “On that basis we still believe a recession is likely either by accident or by design.”

The equity story – up and away?

Stock markets were largely driven this week by investors’ new-found appetite for all things AI. The tech-heavy Nasdaq index rose 2.34%, making for a 27.45% year-to-date gain.

Lewis Grant, Senior Portfolio Manager for Global Equities at Federated Hermes Limited highlighted two contrasting narratives in equity markets at present. On the one hand, he said, conditions are prime for the start of the next bull market. “This is helped by the VIX volatility index being at neat pre-pandemic lows – and by mega-cap growth names benefiting from era-defining technology and easing monetary conditions,” he said.

On the other hand, he pointed to the issue of higher-for-longer interest rates, which, he said, have economies teetering on the brink of recession.

“While this does not necessarily preclude a bull market, previous expectations of a swift decline in rates benefitted growth stocks significantly and revised rate expectations in recent days have left value names winning,” he added.

After the storm: The VIX is now at pre-pandemic lows

This presents investors with something of a conundrum, according to Grant: either they can seek the AI trade, position themselves for a growth rally, or search the bargain bucket for value opportunities.

He added: “The AI trade is still unfolding, and the balance between hardware and software providers will reveal itself over time. We anticipate that the growth rally will front-run the economic recovery, but with stubborn inflation and challenges in the labour markets, a broad growth rally does not appear imminent. In the meantime, the mega-caps continue to offer an attractive blend of growth and safety.”

On a path to economic orthodoxy

In emerging markets, President Erdoğan’s election victory in May continued to spark volatility in Turkish assets. Spreads widened on the back of the election results before returning to their pre-election levels when market-friendly Mehmet Simsek was appointed as Treasury and Finance Minister. In his speech, he reiterated that achieving price stability and reduction of the current account deficit in the medium term are a priority.

Mohammed Elmi, Senior Portfolio Manager for Emerging Markets Fixed Income at Federated Hermes Limited noted that a return to policy orthodoxy seems inevitable given the country’s materially diminished foreign exchange reserves and 40% inflation.

“Our view is that a cautious stance with regards to the Turkish sovereign is still warranted until we see proof of the authorities’ commitment to policy orthodoxy,” he added. “Nonetheless, we believe large Turkish corporates and banks remain well-positioned to weather a material depreciation of the currency and an economic slowdown.”

To learn more about our view on current market conditions, read our deep dive into investment grade credit.

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