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Australian Market Summary | 11 April 2022

Equity markets fell globally with hawkish statements by various central banks, leading to higher bond yields. The MSCI World fell nearly 1%, and the MSCI Emerging Markets fell 1.5%. The Australian stock market performed relatively well, finishing the week slightly down with the ASX200 index falling 0.2% and the Small Ordinaries Index down 0.9%. The best performing sector was Utilities which rose 3.2%, and the worst-performing was Consumer Discretionary which fell 2.9%.

The yield for the 10-year US bond rose 32 basis points last week to 2.72%, on the back of hawkish minutes from the Fed’s March meeting that revealed its plan for quantitative tightening (explored below). The US 2/10-year yield curve inverted after threatening to do so in recent weeks. The Australian 10-year rose 17 basis points to 2.97%.

The RBA held rates as expected in Australian economic news but delivered a hawkish speech removing ‘patient’ from its rhetoric on interest rate rises. The change in wording signals that a hike is coming soon, potentially following the Federal election. ANZ job ads rose 0.4%, and retail sales rose 1.8%. The domestic economy remains strong, and we continue to prefer domestic exposure.

The US Fed took a hawkish tilt “to reduce the balance sheet at a rapid pace”. The release of the minutes showed that, but for the uncertainty of the Ukraine war, many members of the Fed would have favoured a 50 basis point initial hike back in March, setting the tone for more significant hikes in the coming months as the Fed fights inflation before it becomes entrenched in consumer psychology.

China signaled a ramp-up in support to combat slowing growth. Reports of a potential fund to rescue troubled financial firms and USD$2.3 trillion infrastructure spending feature. China plans to broaden projects on the infrastructure plan, with only 30% allocated for traditional roads/rail. Other infrastructure investment includes technology hubs, electric vehicle factories, and logistic parks. China is struggling with lockdowns and weak sentiment; the 5.5% GDP growth target for 2022 may be challenging to achieve, with consensus estimates sitting below that. If China changes/scraps the zero COVID policy and increases fiscal and monetary support, this could support commodities, global growth, and some relief for supply chains.

It is a big week ahead of economic releases. We will get Australian employment data, business confidence and consumer sentiment readings, which will help demonstrate the strength of the local economy. US inflation data is expected to show another rise, strengthening the odds of a 50bps rate hike in May. US quarterly earnings season also kicks off this week led by releases from the big banks. Chinese CPI inflation will rise slightly, but the focus will be on producer price inflation readings.

Quantitative Tightening

The release of US Federal Reserve minutes last week strongly indicated that the Central Bank would start the process of quantitative tightening as soon as next month. We will explain quantitative tightening and its potential impacts on investment markets.

First, it is crucial to understand Quantitative Easing (QE). QE is an expansionary policy where a central bank creates money to buy bonds. The aim is to boost the economy by driving down long-term rates to stimulate and encourage businesses and households to borrow and invest.

The US Federal Reserve pumped trillions of dollars into the economy throughout the pandemic, with its balance sheet more than doubling to nearly $9 trillion dollars. The easy money has helped fuel a bull market in stocks, real estate, and other markets, including cryptocurrency. At the same time, it suppressed the bond yields.

 

Fed officials broadly agree that starting in May, the Fed will shed up to $95billion of assets a month from this vast balance sheet. The Fed will seek to do this predominantly by not reinvesting the proceeds from maturing bonds and reducing its holdings of mortgage-backed securities, potentially through direct sales.

The goal of this quantitative tightening is the opposite of quantitative easing. It aims to reduce money in the system and tighten financial conditions. This will be done simultaneously with interest rate hikes. The Fed hopes the dual-pronged attack will be enough to cool surging inflation.

How will markets react?

The last time the Fed undertook QT was between 2017 and 2019 at around $50billion a month, which is roughly half the expected rate this time around. And this time, it will ramp up to the projected $95billion rate significantly faster pace, likely over three months. It is hoped the Fed has learned from its mistakes in 2019 when the central bank withdrew too much money from the market, resulting in short-term funding rates spiking. The impact caused reverberations across public markets, including a sharp sell-off in equities at the end of 2019, resulting in the Fed reversing course and abandoning QT.

Investors were expecting QT to occur as the Fed removed pandemic emergency settings. However, the pace of its plan sends a powerful signal to markets that the Fed is aggressively targeting inflation. The tightening has the potential to cause problems across the economy, especially in areas sensitive to credit conditions, including the housing market or highly leveraged companies.

We believe volatility may continue to be elevated in the near term. We continue to favour high-quality companies with healthy balance sheets and strong competitive positions, allowing them to withstand this uncertain period.

For more information on the above please contact your Partners Wealth Group advisor directly or on 1800 333 143.

This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.

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