How to respond as markets near a tipping point

May was a month where Central Bank actions and dialogue were disseminated as the geopolitical risks of the Russian/Ukraine conflict was largely forgotten and the market weighed up the inflation versus growth slowdown story. 

The US Fed hiked rates by 50 basis points in early May. US Fed Chairman Powell opined that “inflation is far too high” and there seemed to be agreement among the committee that similar sized rate increases should be on the table for the next couple of meetings. 

ECB members ran with the hawkish baton – hinting at the chance of a 50 basis point hike if inflation broadened as well as the ending of the Asset Purchase Program in the third quarter. Markets and debt-burdened households will now have to adjust to tightening financial conditions with the removal of monetary stimulus. 

These moves will almost certainly provide ongoing volatility to asset markets, potentially taking some asset classes a long way from perceived ‘fair’ value and blurring the signposts that investors often use to make forward-looking decisions.

The impact of higher rates was also substantiated by a slowdown in economic data in US manufacturing, housing and durable goods coming in below expectations. The hawkish overtures from the ECB will be worth monitoring as Europe has long been the anchor for low global rates and the secular lower economic growth story might provide difficulties for the ECB to tighten aggressively.

In Asian markets, China continued to struggle under the Covid-19 outbreak which provided added concerns for the global growth engine. This remains a positive for the inflation story as we anticipate a removal of the supply chain blockages that have plagued us from the commencement of the pandemic. 

Barring any further unexpected shocks, inflation should fall over the balance of the year, with restrictive policy destroying demand to help this process.

Domestically, the RBA who was late to the QE party was now arriving late to the global hiking party as it hiked 25 basis points to a unique rate of 0.35% - with market expectation for a 15 basis point hike. 

We maintain the egregious forward pricing of circa 3.70% rates one year out is not sustainable for the domestic economy without engineering a very uncomfortable hard landing given the sensitive transmission mechanism of higher rates.

2022 is proving a very difficult environment for asset owners as the price of money is set to increase rapidly to temper demand, helping to rein in inflation. 

These moves often lead to a rapid slowdown in the economy and consequently a repricing of assets. Whilst continued rate hikes will certainly produce market volatility, for those that weather these storms there should be fantastic investment opportunities available thereafter. 

Creating a plan for the coming volatility will serve investors well with some obvious trigger events which will guide as signposts to the twists and turns ahead. 

We remain confident that the bond market will become more two-sided in this environment against the backdrop of slowing inflation and Central Bank actions. Watch the video to hear more.

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