October 05, 2023
October 05, 2023
Is the worst of the monetary policy behind us?
October 05, 2023
Equity markets fell rapidly for the second month, following a robust rally in the first half of 2023 as markets adjust to the new regime of heightened volatility and higher interest rates. The S&P 500 Index returned -4.8%1 (USD) while the MSCI Europe (EUR) Index fell 1.5%1. The MSCI Japan Index (JPY) remained marginally positive at 0.5%1. Emerging markets also remained in negative territory with the MSCI EM (USD) Index down 2.6%1. Regionally, the UK market gained significantly as the FTSE 100 Index (GBP) returned 2.4%1 partly due to its tilt towards the energy sector which was supported by a sharp rise in oil prices. The US 10-Year Treasury yield has been well over 4% in September, ending the month at 4.57%2, almost 50bps higher than August end, resulting in the biggest monthly change this year. Given the increase in volatility, the VIX Index has been rising throughout the month, reaching 17.62 at month end.
As expected, Federal Reserve officials left the interest rate unchanged in September. But even though the Fed is on the cusp of its potential terminal rate hike to fight inflation, officials warned that a higher-for-longer approach is likely to be needed to keep inflation under control as long as the economy is strong. While the market attempts to reconcile the higher for longer policy of the Fed amid concerns of a potential recession, it is also probable that another rate hike will occur in 2023. This policy stance could push the economy into a mild recession in the first six months of 2024. However, this could be good for markets as it does not erode the underlying strength of the economy. Moreover, markets may be able to weather a recession that arrives sooner and is milder, rather than a recession that arrives late and could result in a hard landing for the economy.
Financial markets averted further volatility on account of the US reaching its debt ceiling as the last-minute agreement between Republicans and Democrats to extend the government's funding for a further 45 days has postponed the decision on the 2024 budget until mid-November, when Congress will need to reach a decision on the current budget.
As economic headwinds diminish while monetary policy tightening persists, we believe diversification* should remain a priority for investors moving forward.
We did not make a significant number of tactical adjustments and maintained our overall positioning in September as we are confident in our current position and remain aligned with the portfolios’ risk objectives. We maintain exposure to segments of the market that have lagged as they could catch up on the back of better-than-expected macro-outcome. We still prefer carry over duration and have been allocating to cash given elevated yields. We made the following tactical changes in September:
We downgraded our view on EURUSD exposure while still remaining positive, based on our updated assessment of the relative EU-US growth outlook and the challenges facing the Chinese economy, as we no longer see sustained upside in the EURUSD. Real yield differentials are likely to continue to move in favour of the US, opening the door for further EUR weakness.
We also downgraded our view on JPY to neutral as we believe that the Bank of Japan will likely disappoint the market by not adjusting policy in the near term.
The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See Disclosure section for index definitions.