Multi-Manager People’s Perspectives

The economic data has been good, almost too good, leading investors to conclude that interest rates will need to stay higher for longer to bring inflation down towards central bank targets.

It’s also been a busy time in politics, and in a week where the US celebrated the President’s Day bank holiday, it seems apt that the headlines have all come from various Presidents – Biden, Zelensky and Putin. With the one-year anniversary of the Russian invasion of Ukraine today, the focus has been on what has been achieved (or more specifically what hasn’t) and what comes next. President Biden visited Ukraine and met with President Zelensky in Kyiv on Monday and promised further military aid. His strongest comments came in a rebuttal to President Putin’s speech in Moscow on Tuesday. President Putin announced the suspension of the New Start nuclear arms treaty with the US, signed in 2010, which caps the number of nuclear warheads held by the US and Russia. Putin gave no indication of how the war might end but said of the west “they were the ones who started the war…we’re using force to stop it… this is about the very existence of our country”. Biden retorted that “the west was not plotting to attack Russia, as Putin said… this war was never a necessity, it’s a tragedy. Biden added “every day the war continues is his [Putin’s] choice. There should be no doubt, our support for Ukraine will not waver, NATO will not be divided, and we will not tire”. Biden’s pledge of around $500 million of additional aid is on top of close to $45 billion of existing support, split between $30 billion in ‘lethal assistance’, $13 billion in budget support and $2 billion in humanitarian aid.

China appeared to be getting drawn into the diplomatic arguments with their top diplomat Wang Yi engaging in a fractious meeting with US Secretary of State Antony Blinken at the Munich Security Conference. Blinken told US media “we are very concerned that China is considering providing lethal support to Russia in its aggression against Ukraine”. Ahead of meetings with the Russian foreign minister, Wang Yi described relations as “rock solid” while the Chinese government said they would “push for talks”, calling for parties to stop “fuelling the fire” in Ukraine. The endgame to the conflict remains very unclear – it would seem we are a very long way from peace talks, with Ukraine unwilling to cede territory, while Russia seems likely to make a renewed assault using troops mobilised last year. Financial markets do not appear unsettled by any of the latest headlines, and in reality, this will likely remain the case in the absence of disruptions to supply chains or a rebound in energy prices.

The economic data has been solid, indeed the relative strength of the data across developed markets was a headwind for financial markets, raising the prospect of interest rates moving higher, and staying there for longer. The flash PMI data showed the US, eurozone and UK moving back into ‘expansion’ territory, with numbers well ahead of expectations. In the US, the services sector drove the strength of the data while manufacturing remained in contraction. This was mirrored in the eurozone where manufacturing weakened further but this was more than offset by the strength of the services sector. The UK saw manufacturing still in contraction, but only just, while services accelerated back into expansion territory.

The data gave more weight to the argument that we are not yet seeing western economies on the cusp of recession, with significantly lower energy prices a strong tailwind and the continued strength of labour markets helping consumer resilience. Not to sound like a broken record, but with the lagged impact of rate hikes likely to have more of an impact as the year progresses, we are not convinced this relatively benign economic backdrop can continue. But for now, the data is holding up well. But there are still cracks appearing – look no further than the US housing market, which has slowed significantly as a result of rising mortgage rates. The main 30-year mortgage rate in the US is now 6.95% – this was 3.3% at the start of last year. US mortgage applications last week were at a 28-year low, while existing home sales for January were down 37% year on year.

The newsflow from the central banks has been quiet, with the exception of the minutes of the Federal Reserve meeting in January, when they shifted down to a 25-basis point rate hike. The minutes showed that participants in the meeting “observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2%, which was likely to take some time”. The market reaction to the news was muted; the Fed meeting took place a few weeks ago, since then we’ve seen very strong jobs data, sticky inflation data and markets repricing for a ‘higher for longer’ environment in both inflation and interest rates. The gap between market pricing and the signals from the Fed has closed markedly with interest rate futures now broadly in line with what Federal Reserve members are projecting for where rates will end up. There remains a mismatch between what the market thinks will happen next – i.e. rates coming back down in short order, and Fed members who expect to stay on hold at the peak level of rates for an extended time. With the US economic data still in good shape, at the moment good news for the economy may not be good news for markets as a stronger economy points to the need for higher rates to bring inflation down sustainably.

Our asset allocation meeting on Wednesday saw us making no changes to our regional weightings – we continue to favour Asia and the Emerging Markets at the margin – but we did make some top-down changes. We are increasing our underweight in equities closer to levels we saw at the start of the year. This will be added to cash for now. We are not adding further to our already overweight position in bonds given the strong recent returns from this asset class. We do feel the market mood shifting somewhat to recognise the risks from persistent inflation and the actions the central banks will need to take to counter it.

2023 has seen a strong start in terms of economic data, but we remain of the view that we will begin to see the impact of the aggressive rate hikes that began in the spring of 2022 on developed economies as the year progresses. We will continue to be nimble in adjusting our portfolio beta, but for now we are happy to hold a little more cash, which as rates increase is becoming more ‘investible’. We also expect to hold a proportion of our cash weighting in gold, which we see as an insurance hedge against several factors around rates and central bank policy as well as, to a lesser degree, geopolitical issues that continue to give us some concerns.

Lastly, in the interests of research, I took a trip round our local supermarkets yesterday in search of salad – news headlines this week have made much of the ‘rationing’ of lettuce, tomatoes and cucumbers with various reasons blamed, poor weather in Spain and Morocco, and inevitably Brexit once photos of fully stocked shelves in Ireland and across the EU appeared on social media. Is Brexit to blame for lettuce shortages? I’ll leave that debate for leaf and romaine supporters to argue over…