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Economic Commentary by Conrad Burge, Head of Investments

Published 31 May 2023

Economic Commentary by Conrad Burge, Head of Investments

The global economy continues to feel the effects of measures being taken to counter what has been a significant rise in inflation since early last year across most of the advanced economies. As the International Monetary Fund (IMF) noted in its April report, ‘although inflation has declined as central banks have raised interest rates and food and energy prices have come down, underlying price pressures are proving sticky, with labour markets tight in a number of economies’. In fact, actions taken from early 2020 to counter the pandemic, including unprecedented government spending programs to sustain employment, have been a major factor behind this rapid rise in inflation. These programs helped to push employment to historically high levels (and unemployment to historic lows) but they also helped to push wage rates higher, which, without the dampening measures being taken, could lead to what is known as a ‘wage/price spiral’. However, key central banks (including the US ‘Fed’, the European Central Bank and the Bank of England) have raised interest rates at an unprecedented pace and this is likely to be effective in lowering inflation. In fact, there are signs that inflation has begun to stabilise in some areas and central banks could soon ‘pause’ in hiking rates.

In the case of the US, the ‘Fed’ has recently reduced its rate of tightening and it could soon halt further rate rises, at least for a time, while it analyses their full effect on economic activity. The annual inflation rate dropped to 4.9% in April, well down from its peak of 9.1% last June. On the other hand, inflation remains stubbornly high across Europe. As well as rate hikes, central bank measures have included ‘quantitative tightening’ (in contrast to ‘quantitative easing’ during the pandemic) to take money out of the financial system through the sale of bonds and other assetbacked securities held on their balance sheets. This tightening of monetary policy has slowed economic growth and the IMF is now forecasting global growth of 2.8% this year (1.6% for the US, 0.8% for the Euro zone and 1.3% for Japan), with ‘risks heavily skewed to the downside’.

The Australian economy was able to maintain solid growth in 2022, buoyed by strong household spending, despite interest rates being lifted significantly over the year. The economy grew by 2.7% over the year to 31 December, with household spending up 5.4%, although private investment declined. Unemployment remains historically low but has begun to rise this year as the economy slows under the weight of higher interest rates. With the annual inflation rate still running at 7.0% for the March quarter, rates may have to rise further.

Most share markets began to slide in early 2022 in response to signs of rising inflation but there has been some recovery in markets since late last year. This year, up to 22 May, market movements have included rises of 9% for the broad US market (S&P500), 22% for the technology-focused Nasdaq, 4% for the UK, France 16%, Germany 17%, Japan 19% and China 7%, while the Australian market rose 3% and India rose 2%. Most markets appear to be fairly valued, assuming that interest rates soon stabilise.

Major sovereign bond markets saw yields reach record lows in March 2020 as central banks sought to push rates down to lift economic activity in response to the outbreak of the pandemic. However, sovereign bond yields trended up through 2022, as economies re-opened. The US 10-year Treasury bond yield fell to an historic low of 0.54% on 9 March 2020 but was 3.71% on 22 May this year. Similarly, the Australian 10-year bond yield was 0.57% on 8 March 2020 but was 3.59% on 22 May 2023. Some bond markets could experience lower yields this year if growth softens significantly.

Fiducian’s diversified funds are currently around benchmark for international shares, domestic shares and listed property. Exposure to fixed interest sectors has been lifted but is still marginally underweight, while cash holdings remain above benchmark.