3.      Fixed Income Markets

Central banks have made it their explicit priority to contain inflation. This means a fast adjustment higher in interest rates set by Central Banks is the policy response. The pace of this adjustment higher is highlighted by the below chart. These rates are expected to increase further and potentially at a faster pace as markets begin to bet on a 1% increase at the next Federal Reserve meeting due to the reacceleration in inflation within the July number.

The pace of these increases has caused significant selloffs in fixed income as interest rates have increased across the quarter. Significant interest rate increases have mostly been priced into these markets.

Whilst short-term rates continue to rise, there has been some stability and even decreases in long term rates. This signals that central banks will not be able to raise rates indefinitely as the increasingly tightening financial conditions will force an eventual reversal in this policy.

4.      Outlook

Research’s outlook on the current environment has moved more negative as inflation becomes a bigger issue that central banks have explicitly outlined needs to be addressed.

Within equities, interest rate increases have put pressure on the ‘growthy’ technology parts of the market. These stocks have already been heavily impacted across the entirety of this year so far. Whilst some of these areas may be starting to look attractive, interest rates will continue to halt speculative investing in the short to medium term. If inflation begins to moderate and decrease and therefore pressure lessens on central banks to continue to increase rates, then this part of the market will react positively. The ‘value’ stocks have performed very well over the past year and a safe haven to the ‘growth’ stock downside. This has halted in the past month as a recessionary environment looms on global economies. Remember, ‘value’ stocks are more economically sensitive and will be impacted heavily as economic activity decreases. This ultimately means that there may be no safe places to hide within equities over the coming months. Research have increased exposure to low volatility managers that put strong emphasis on downside protection when markets are falling. This is recommended to help stem the losses in the equity components of the portfolio.

Within fixed income, a lot of the losses and the future interest rate increases have already been priced in. If inflation continue to increase, there may be further losses, however if a slowdown in economic activity continues to play out, it is likely this begins to moderate over the medium term. This means that it is important to maintain exposure to these investments as a recessionary environment would allow fixed income to finally begin to play defence for your portfolio. This hasn’t been the case so far as interest rates have increased along with inflation. Make sure to not panic in this environment and have faith that the fixed income part of the portfolio will begin to show signs of positive improvement.

Remember, if inflation moderates and an economic slowdown begins to show up in the economic data, all central banks have to do is state that interest rates will not be raised as much as they have been and even look to cease the rate rises all together. If they did this, bonds will rally along with stocks as less pressure from interest rates is extremely positive for both bonds and equities. This may take time to play out, but now is not the time to sell down a portfolio, especially the fixed income side of the portfolio. Instead using instruments like Term Deposits and short-duration income fund managers may help decrease the volatility.