Since our last update, bond yields (which move in the opposite direction to bond prices) have tracked higher, and equities have experienced another move downwards. So, it’s been more of the same for investors, unfortunately.
In the driver’s seat has been a rapid increase in consumer prices, which has resulted in inflation rates in many countries reaching levels not seen in decades. In New Zealand, for example, the inflation rate for the year to September was 7.2%, which is the highest it has been since 1990. Central banks have continued to increase their target interest rates at pace, which has driven bond yields higher. The aggressive approach by central banks to bring inflation back to a more acceptable level (which is seen to be around 2%), risks putting several economies into recession next year. With that in mind, the performance of equity markets has been weaker.
New Zealand is a small open economy, and because of this, the value of our currency is tied to the outlook for global growth, among other things. This has seen the New Zealand (NZ) dollar weaken for much of this year. As such, we recently increased our exposure to the NZ dollar and reduced our exposure to foreign currency. This was based on our view that a lot of negative news had been incorporated into the value of the NZ dollar, thereby improving the reward to risk trade-off.
Towards the end of October there was a noticeable improvement in risk sentiment. An article appeared in the Wall Street Journal suggesting that the US Federal Reserve (Fed) might be getting closer (possibly at its December meeting) to reducing the pace of its interest rate increases. This was followed by the Bank of Canada raising its target interest rate by less than expected (0.50% instead of 0.75%), and market participants interpreting the European Central Bank’s messaging as being less aggressive on tightening (i.e. rate hikes) going forward. This saw bond yields fall towards the end of the month. There was also an improvement in risk appetite, and most equity markets actually delivered a positive return for the month of October (the US equity market was up 8%, while the NZ market was up ~2%).
In early November, as expected, the Fed increased its target interest rate by another 0.75% to a range of 3.75-4.00%. In its accompanying statement, it all but confirmed that it will step down to a 0.50% rate hike at its December meeting. This is the good news that market participants were hoping for. However, that was offset by the Fed noting that the peak in its target interest rate may be higher than previously anticipated.
So, what are we to make of all of this? In a nutshell, inflation is still too high. Central banks are likely to continue increasing their target interest rates until at least some point in the first half of next year. Bond yields will probably increase a wee bit further until it’s clear that central banks have inflation under control. And, although equities have already priced in a lot of the negative news about a recession next year, there are a number of factors at play that create some downside risk (e.g. the slowdown in China’s economy and the impact of its zero-tolerance approach to COVID-19 on supply chains; the war in Ukraine).
It’s been a tough year so far for investors. There’s no doubt about that. The best thing we can do though is to try to take some comfort from the knowledge that if we’re patient, and stay the course, we should receive the benefit of a better return than cash over the long term. As we know, there are risks associated with investing, but there are also rewards. The way I like think of it is that bond and equity markets wouldn’t exist if investors in those markets weren’t rewarded over the long term.
This article is solely for information purposes. It’s not financial or other professional advice. For help, please contact BNZ or your professional adviser.
No party, including BNZ, is liable for direct or indirect loss or damage resulting from the content of this article. Any opinions in this article are not necessarily shared by BNZ or anyone else.