tightrope walker

Investment Commentary – December 2022

2 minute read

Markets built on a strong October with further gains in November. The rally has been particularly strong from those assets most impacted by the persistent selling this year. Asian and European equities rose most, boosted by a weakening dollar, easing commodity prices and falling bond yields. Developments to inflation, interest rates and bond yields continue to fixate markets and it was good news in these areas that have supported asset prices. Inflation readings from the US and Europe came in below expectations and lower on the month, allowing fixed income markets to begin pricing in a slowing rate of monetary tightening.

The keenly watched US CPI data posted a 7.7% annual reading for October, down from 8.2% in September and significantly below expectations of 8%. This rapid decline as well as signs of a slowing labour market gave ammunition to those foreseeing the peak in interest rates. Although prices for many core components of CPI remain higher year on year, rate of change is slowing and there are some month on month falls occurring. Furthermore, core input prices, such as energy, metals, food, logistical costs as well as overstocking of inventory all point to further declines in future months. Falling inflation in the US was supported by weaker than expected and declining headline inflation in the Eurozone in a flash estimate for November. These developments were acknowledged by the Federal Reserve Chairman Jerome Powell during a speech at the end of the month, where he guided markets for a lower pace of rate rises and suggested the next move may be smaller than the recent 0.75% changes. This news was welcomed by markets, with US equities rising 3% and bond yields falling.

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In the UK, the outlook is more complicated, as inflation remains high and rising. The proposed increase in the energy price guarantee due in April 2023 also means that the fallback in the headline inflation figure will be further out and may take longer to normalise. This may force the Bank of England to continue with aggressive rate hikes. However, the economic outlook is also very weak, suggesting rate cuts should be considered. The Monetary Policy Committee will have some challenging decisions over the coming months and there is rightfully a significant degree of uncertainty regarding UK interest rates. However, it is worth considering that the Bank has a sole mandate targeting inflation, meaning that if inflation is judged to not be falling back fast enough rates should be raised regardless of the economic impact. Although these factors are naturally interconnected.

Over the coming months, investors may well develop a bad news is good news approach. Signs that an economic slowdown or recession is taking hold and impacting the labour market could be considered a positive as it may bring on monetary easing. However, much will depend on the severity of any slowdown, the impact on inflation and the absence of any further external shocks, particularly in energy.