Faster is better | BetaShares

Faster is better

BY David Bassanese | 28 March 2022
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Global markets

There continues to be a strange divergence in global financial markets. Global bond yields surged further last week as strong U.S. economic data and hawkish Fed rhetoric saw bond markets almost fully price in a 0.5% rate hike at the May Fed meeting – in line with my base case outlined last week. Fed chair Powell suggested he’ll do what it takes to get inflation under control, while the Fed’s Bullard said “faster was better” when it comes to getting interest rates at least back up to neutral. The Fed seems to be hoping that aggressive early rate hikes could tame inflation while avoiding a hard landing or recession, as evident in 1994.

The equity market meanwhile continues to rejoice at strong U.S. economic data – the February services and manufacturing indices were both stronger than expected, and weekly jobless claims dropped to their lowest level since 1969! Indeed, equities of late have become blithely untroubled by the surge in interest rates, with U.S. 10-year yields blowing though my 2.25% target to end last week at 2.48%. Equity investors are betting on a soft landing, or at least remain confident the Fed will backtrack at the first signs of economic weakness – even if inflation remains uncomfortably high.

As I indicated last week, I’m not too sure of this – given the already very low level of unemployment (3.8%) and runaway wage growth. It remains to be seen whether a hard landing really is required to get inflation under control and, if so, whether the Fed really has the ticker to do a Volcker if required. The real test will be the Fed’s reaction when economic growth and earnings expectations inevitably start to slow under the onslaught of higher interest rates. Meanwhile, the U.S. S&P 500 is still trading at 19.5 times forward earnings. With 10-year bond yields at 2.5%, this implies a relatively low (by the standards of the past decade or so at least) equity-to bond yield gap of 2.6%. And if you think that’s bad – I predict U.S. 10-year yields will hit 3% by early 2023.

This week should reveal more evidence of the red-hot U.S. economy, with March payrolls on Friday and the February private consumption price deflator one day earlier. A bumper 475k in job gains is expected, with the unemployment rate expected to drop to 3.7% and annual growth in average hourly earnings rising from 5.1% to 5.5%. Annual growth in the core consumption deflator is expected to rise to 5.5% from 5.2%. There’s also a further bunch of Fed speakers who will publicly debate the speed at which rates should be increased.

Such is the equity market’s optimism, even the growth/technology sectors have rebounded in recent weeks.

Australian market

The key local development last week was RBA Governor Lowe again reiterating that he’s watching inflation expectations a bit more closely these days – implying he’s probably more inclined to raise interest rates in coming months even without annual wage growth first accelerating to above 3%. Indeed, Lowe also noted emerging evidence that businesses were finding it somewhat easier to pass on cost increases. Firmer global commodity prices have  helped push up the $A to US75c, while local bond yields continue to surge in line with those in the U.S.

A highlight this week will be Tuesday’s Federal pre-election Budget, which is likely to see much of the lift in revenues due to better than expected iron-ore prices spent rather than saved, despite a still yawning budget deficit. This will only bolster the nearer-term economic outlook and adds to upward pressure on local interest rates. It also again highlights that fiscal austerity is a distant memory – if a Government can’t tighten the budget in today’s booming economic times it never will!

Have a great week!

2 Comments

  1. Fred Pascher  |  March 28, 2022

    Hi, David’s insight always a pleasure read.
    Suggest that also the 2 year $AUS and $US Bond yields are included in charts to compare re: inverse curve.
    Thanks. Fred

    1. BetaShares Client Services  |  March 31, 2022

      Hi Fred,

      Thank you for taking the time to provide your feedback and suggestion – it is very appreciated. I have passed this feedback on to the relevant parties.

      Sincerely,
      BetaShares Client Services

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