Global markets seesawed a bit in recent weeks, but then jumped higher in recent days on the back of some softer U.S. inflation data. Bond yields had similarly large moves. There were additional notable U.S. developments too: another outsized interest rate hike and mid-term elections. While undoubtedly headline-grabbing in nature, we don’t view the investment outlook as having meaningfully changed. We discuss more below.
In recent days, the October reading of the consumer price index (CPI) in the U.S. was released. The index rose 7.7% year over year, suggesting inflationary pressures are still very high. However, the reading was below most forecasts, and marked a deceleration from the previous month. The October release adds some credence to the view that the U.S. may be past the worst of the inflationary pressures, for now.
The weaker inflation data is also likely to fuel the debate as to when the U.S. Federal Reserve can slow its aggressive rate hiking campaign. The Fed recently raised interest rates by 0.75%, the fourth consecutive outsized move. More noteworthy were Mr. Powell’s comments, in which he indicated the pace of future rate hikes will inevitably slow at some point, similar to the messaging from other central banks like the Bank of Canada. However, he affirmed it is premature to talk about a pause, and strongly indicated that rates will still have to be higher and more particularly “sufficiently restrictive” to slow the economy, reduce inflation, and most importantly ensure future inflation expectations stay contained. That left investors wondering whether rates will not only be higher, but remain so for a longer duration.
Meanwhile, the much ballyhooed U.S. mid-term elections took place recently. The results are not completely finalized as there are still races that are too close to call. The Republican Party did not dominate to the extent that was expected, as some projected the Party would take a decisive amount of seats in both chambers of Congress: the Senate and the House of Representatives. But, the outcome was still in-line with general expectations: a divided government, with the Presidency occupied by one party and one or both chambers of Congress occupied by the other. This will make it challenging to pass any meaningful legislation over the next two years. Nevertheless, this kind of a setup has historically proven to be a positive tailwind for equity market returns, particularly after mid-term elections.
Politics aside, the investment outlook, in our view, still boils down to the following. Inflationary pressures remain high but should weaken over the next year, driven by a combination of factors such as lower commodity prices, supply chain normalization, tighter financial conditions, and challenging year over year comparisons. As inflation slows, so too should the pace of interest rate hikes from central banks, which should lead to greater market stability, particularly in the bond market. Economic momentum should also fade as this year’s rate hikes begin to more meaningfully affect the behaviour of consumers and businesses. A recession seems almost inevitable, but it may take some time to develop. The North American economies have proven to be resilient, with businesses still looking to hire and consumer spending remaining robust. We expect this to eventually change at some point in 2023.
In sum, challenges lie ahead. But, the markets have undergone a significant repricing this year given the inflationary backdrop. That has resulted in a wide range of income producing opportunities that now look relatively attractive. We intend to explore some of these for our portfolios based on our view that income will be an even more important contributor to total returns for our clients over the coming year.
I am pleased to share the latest investment strategy report from RBC Wealth Management: Global Insight Weekly.
Highlights:
An unsettled environment
Global risk sentiment remains volatile in the face of many macro crosswinds. While some parts of the macro landscape could deliver positive surprises, we think an unusually wide range of potential economic outcomes warrants a modestly defensive stance in portfolio positioning.
Regional developments: Canada continues to add jobs; U.S. markets rise as inflation slows; European earnings season trends; China appears to prepare for reopening.
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