Fiducian Economic July 2022 commentary

The global economy is continuing to face headwinds. In April, the International Monetary Fund (IMF) explained that ‘global economic prospects have worsened significantly’ and ‘the outlook has deteriorated largely because of Russia’s invasion of Ukraine’. More recently, the environment has weakened further, with the IMF in its most recent report (July) referring to ‘increasingly gloomy developments in 2022’. These include ‘higher inflation worldwide, especially in the US and major European economies, triggering a sharp tightening in global financial conditions; a sharper than anticipated slowdown in China, reflecting COVID-19 outbreaks and lockdowns; and further negative cross-border effects from the war in Ukraine’. It adds that ‘since 2021, consumer prices have consistently risen faster than widely expected’, so that ‘central banks of major advanced economies are withdrawing monetary support more assertively and raising policy interest rates faster than expected’. One effect of all this is that ‘the associated rise in longer-term borrowing costs have led to precipitous declines in equity prices, weighing on growth’. As a consequence, the IMF has had to lower its global growth forecasts to 3.2% for this year and to an even lower 2.9% for 2023.

In view of these ongoing tribulations, it is not surprising that ‘the risks to the outlook are overwhelmingly tilted to the downside’. In the US, the annual inflation rate reached its highest level in more than 40 years in June (9.1%) and is likely to remain elevated. For the developed world as a whole, the IMF is now forecasting an inflation rate of 6.3% for 2022, although more encouragingly, inflation is forecast to dip to 3.3% in 2023, ‘reflecting confidence that inflation will decline as central banks tighten policies and energy price base effects turn negative’. With some governments continuing to resort to large spending programs, central banks are currently the only bulwark against rising inflation. Jerome Powell, Chairman of the US central bank (the ‘Fed’) noted on 16 March that ‘we have a plan over the course of this year to raise interest rates steadily and also to run off the balance sheet’ (implying that ‘quantitative tightening’ is to replace ‘quantitative easing’, which was ended in early March). Other central banks are pursuing the same course, although the European Central Bank and the Bank of Japan are tightening only slowly.

The Australian economy expanded in the March quarter, but inflation has also picked up (to an annual rate of 6.1% in the June quarter, the highest rate in over 40 years), prompting the Reserve Bank to tighten policy by hiking interest rates and also by reducing the amount of liquidity in the financial system. This policy tightening is expected to slow growth over coming months, but the country may avoid a near-term recession.

Most share markets trended strongly upwards from the start of monetary and fiscal stimulus in early 2020 through 2021. However, this year has seen markets falter, especially after the Russian invasion of Ukraine. Up to 29 July, market movements have included declines of 13% for the broad US market (S&P500), 21% for the technology-focused Nasdaq, Germany 15%, Japan 3%, China 11%, India 1% and Australia 7%, while the UK market actually rose 1%. In this uncertain environment, markets could be volatile for some time.

Major sovereign bond markets saw yields reach record lows in March 2020. Central banks subsequently tried to keep rates low to lift economic activity, although longer-term bond yields have moved up this year. The US 10-year Treasury bond yield fell to 0.54% on 9 March 2020 but was 2.65% on 29 July 2022. Similarly, the Australian 10-year bond yield was 0.57% on 8 March 2020 but was 3.06% on 29 June 2022. Despite this lift in yields and despite a slowing economic outlook, most bond markets continue to appear expensive.

Fiducian’s diversified funds are currently slightly below benchmark for international shares, domestic shares and listed property and well underweight fixed interest sectors, while cash weightings remain well above benchmark.

Source: https://www.fiducian.com.au

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