Central banks have done little in the way of monetary policy changes over the last quarter, although policy remains very loose across the board. The major announcement was from the Federal Reserve, modifying its inflation targeting. Going forwards, they are looking to target an “average” 2% rate of inflation, suggesting that there will be willingness to allow inflation to run higher to make up for the current period of undershooting the 2% target. Practically, this implies that rates will continue to be held low and result in even deeper negative real yields, possibly for a long period. Futures markets are suggesting that there is a possibility of negative rates in the US, which would likely be a market changing event for global asset prices, most of which are based off dollar funding.
Once again, there has been very little change in the US yield curve over the quarter, although there has been a marginal shift lower. While it is encouraging that the curve is upward sloping, in reality there is very little in it.
In the UK the Bank of England has attempted to reassure the market that it has ample firepower and is willing to use it if needed. The suggestion is that there will be additional rounds of Quantitative Easing or further cuts to interest rates if there is a deterioration in the economy outside of current forecasts. UK government bonds are suggesting that over the medium term (2-5 years), there is a reasonable probability of negative rates.
The ECB continues to maintain negative rates at -0.5% and asset purchases of at least €20bn per month. There have been no surprises, and as we have discussed before, given the current policies of the ECB it is difficult for them to provide a surprise loosening to the market.
Overall, it is reasonable to expect that there will continue to be very loose monetary policy for the foreseeable future. There is also asymmetry as additional loosening is likely if there is further weakness in the economy or markets, but Central Bankers will be very unwilling to tighten, even if there is an improvement in the data. Nevertheless, expectations can change very quickly.
The oil price has edged higher over the quarter as the extreme oversupply eased its way out of the system. The market continues to be supported by supply cuts from OPEC as well as the steep decline in US production, caused by the lower price. Resultingly, it is unlikely that there will be scope for large oil price rises in the near term as an increase in demand should be easily met by the current excess capacity. At the current level, oil will continue to feed through into lower inflation until Q2 2021, at which point it will turn from a headwind into a tailwind.
Gold staged a sharp rally in July/August smashing through the all-time high and through the phycological $2000/oz barrier. However, it appears that the metal entered overbought territory and there has since been a period of consolidation. Many continue to believe that there are long term tailwinds from this point, however, it is unlikely to be a smooth journey. This has been very clearly illustrated in the quarter. As a defensive diversifier, providing protection against low-interest rates and inflation, gold continues to look attractive at this level.
Understandably, property investments continue to perform poorly. Most observers are still struggling to anticipate what the demand for physical property will be, and there remains significant divergence by type. Offices and retail are most in focus as areas of extreme disruption and a likely reduction in demand. The question now though is how much of this is already priced into markets, which are often already suggesting a 30% fall in capital values.
The bulk of our alternatives continue to deliver robust performance. The gold positioning that we reduced but retained at the last rebalance has delivered a positive return, however, following the very rapid rise in July, there has been a pullback in the gold price in August. The current level continues to be appropriate with the broad 2% allocation that remains.
The Macro fund allocations, predominately through the JPM Global Macro Opportunities, have also delivered positive returns. Which for the JPM fund, is particularly pleasing as it has continued to deliver during all market conditions this year.
Finally, infrastructure, which has been increasingly used within portfolios has broadly traded sideways over the quarter, underperforming the wider equity market. Infrastructure continues to look cheap and we are confident that the long duration, inflation-protected nature of infrastructure will become increasingly in favor with investors over the coming years, even if equities or the global economy falter.