End of interest rate rise cycle?
Our expert Investment Management team at True Potential Investments give their views on markets throughout October 2023.
Over the short-term asset markets continued to exhibit volatility in October, with a challenging month for both equities and bonds. Investors continued to focus on interest rates being “higher for longer”, negatively feeding into asset prices.
However, third-quarter US company results have been generally positive. 78% of companies are reporting better than expected results, with Amazon’s strong revenue figures and Intel’s strong revenue and earnings figures particular highlights. Companies that have disappointed investors have seen more negative share price reactions than in recent quarters.
The Israel/Hamas conflict has so far had limited effect on developed market asset prices, however there is nervousness that further escalation could feed into higher oil prices.
The United States.
In the US core Consumer Prices Index disinflation is evident.
We are therefore closely monitoring for signs of headline inflation bottoming and beginning to trend higher.
The increased supply of US Bonds to fund fiscal spending is having the effect of tightening financial conditions in the States.
The combination leads us to believe we have seen the last interest rate hike from the Federal Reserve for this cycle.
However, given the resilience of economic growth and requirement to bring inflation to target, the Federal Reserve have scope to hold interest rates higher for longer.
Rest of the World.
Investors are facing a less synchronised global economic cycle in relation to growth, inflation, and monetary policy.
Core inflation dynamics in Europe have been stickier amid weaker growth, however we anticipate Core disinflation momentum to build.
Given disinflation momentum and weaker growth, we anticipate that the European Central Bank has reached the end of its interest rate hiking cycle.
The market is looking for a stronger growth stimulus from China to support domestic property and manufacturing, which would have positive implications for Europe.
The UK faces similar challenges to Europe, with stagflation (slow economic growth, rising prices and rising unemployment all happening at the same time) a possible scenario. With strong disinflationary momentum through the second half of, 2023 we expect the Bank of England to bring their interest rate hiking cycle to a close.
Our asset class views.
In a world of real economic growth and continued disinflation, equities remain our favoured asset class. Fund Managers have been tactically leaning into quality as a style factor, accessing businesses with strong balance sheets that are able to withstand a period of “higher for longer” interest rates.
We favour Sovereign Bonds (issued by Governments) over Corporate Bonds (issued by businesses). Our preference is for shorter-term options, as they offer more attractive yields and less potential for volatility, given the interest rate cycle.
Returns from Bonds have proven correlated to Equities over very recent history, however we believe the higher yields on offer present better return potential. Our outlook on Gilts continues to be positive given the risk the UK could enter a period of stagflation, relative to a more robust US economy.
Alternatives remain a structurally important component of our True Potential Portfolios and a diversifier to Equities and Bonds.
Cash still provides a source of both yield and diversification, and a higher hurdle for investment in risk assets. However, cash produces a negative real terms yield once adjusted for inflation.
In terms of currency, the US dollar has remained strong and proven a safe haven in recent times during negative asset price moves. Sterling continues to be weak, given the UK economic outlook leading to a lower probability of further significant interest rate rises.
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