Reflections of the CIO… June 2023

June also brought with it another rise in European and UK interest rates and a ‘pause’ in the USA, albeit one that is only likely to last a few months before rising again. The reason for the continued policy tightening is that although inflation is, in general, falling from its highs, it is also proving to be stickier than hoped, and in some cases such as the UK, even rising again. In the minds of central banks the inflation battle is not yet won, even though very good progress has been made. Their view that interest rates need to be ‘higher for longer’ has finally worked its way into bond markets over the last month or two, a process which has made returns from this area generally weak and uninspiring.

Putting it all together, the top down economic picture at the halfway point in the year has become marginally easier to interpret, as both inflation and growth trends are generally pointing downwards. However the implications for asset markets remain a much harder read. Investors and central banks remain glued to the latest data releases for insights and guidance, which in turn encourages short term thinking. There is a feeling of growing impatience waiting for a promised recession which has not yet arrived, whilst at the same time a hesitancy to embrace the recent positive momentum in case it evaporates later in the year.

It is the stresses which have yet to seriously appear which keep a lid on our enthusiasm for  a big change in our risky asset exposures. Property markets, for example, are an obvious source of concern as the sector remains under stress globally in both the commercial and retail sectors. Smaller banks in the USA have particular exposure to this, to say nothing of the problems China faces in restructuring its enormous property sector as it limps on from the implosion of the last two years. Many of the loans that back these assets are held privately and lack transparency, making the scale and seriousness of the potential problem hard to gauge. It would seem unlikely that we have seen the end of the slip ups only one year into a period when interest rates moved sharply up from zero towards the more ’normal’ levels we have now.

Weighing all these competing influences we feel the most likely medium term scenario is likely to be an ongoing  ‘muddle through’ for markets. When zooming out to think about a time period for the year just passed and the one to come, a range trading environment full of events and noise, but with broadly sideways movement is our central case scenario. That is still an environment rich with opportunities, and we have been busy in June adding gently to riskier emerging market debt, whilst also opening our first positions in decades in shorter term UK government bonds. Both decisions are underpinned by valuation arguments and we would expect similar opportunities to continue to emerge as we move through the remainder of the year.