Market hopes of a Fed policy pivot were dashed yet again this week. As we expected, the Fed remains firm on turning its policy rate, now at a 14-year high of 4%, more restrictive until the spectre of inflation has been sustainably quashed. Chair Powell signalled that the central bank’s 4.75% terminal rate projection, upgraded only in September, is likely to be revised higher next month. Markets are pricing in a terminal rate of 5.25% by May 2023, up from 5% priced a week ago. All this means the equities rally since mid-October may be long in the tooth.
When will the Fed turn and when will bond yields peak? History suggests the US 10-year government bond yield peaks just before the Fed rate hiking cycle tops out. Going by this week’s surprisingly strong US job openings data and Fed comments, we are likely to see that peak only in H1 2023. Even as some areas of US economic activity start to slow – as signalled by the near-stagnation in US ISM Manufacturing PMI data – the Fed will need to be sure that the US job market is cooling enough to dampen wage pressures and services sector inflation. Unfortunately, data this week showed that the services sector activity, which accounts for more than two-thirds of US output, while slowing, remains robust. US households have over USD 2trn of savings, which they are deploying for services consumption as life normalises after two years of the pandemic. The robust job market is adding fuel to this consumption trend.
Friday’s payrolls data is the next focus. The consensus estimates around 195,000 net new jobs were added in October. That rate of job creation is twice what is needed to maintain the current jobless rate around the 50-year low of 3.5%. The Fed expects the jobless rate to surge to 4.4% by the end of next year, which implies that it anticipates a significant slowdown in the economy over the coming year as tighter monetary policy starts to bite with a lag. A resolutely hawkish Fed in the face of slowing growth suggests the US corporate earnings growth estimate (5% for 2023) has further downside. The S&P500 has pulled back from its 100-DMA resistance, below the prior support of 3,800. The next technical supports are around 3,660 and 3,570.
Here’s what you can do as an investor, Standard Chartered advice to, Rebalance into Investment Grade corporate bonds in Developed Markets and Asia and some deeply undervalued equity markets such as Asia ex-Japan and the UK.
Rotate into high-quality income assets. Decade-high yields from the bonds segment of our model multi-asset income strategy (yielding c.7%) are likely to more than offset any near-term price declines as Fed rates rise further. The high dividend equities segment, which accounts for almost a quarter of the model allocation, remains more resilient than broader equities – the Global High Dividend equities index is down 14% YTD vs 23% drop in global equities. This segment offers the opportunity to collect attractive dividends while staying invested in quality companies and awaiting an eventual Fed pivot likely next year.
Risk-manage through cash/cash-like assets and the USD, which would provide dry powder to pick up assets as the rising risk of a recession means more assets go on sale in the coming months. Energy sector equities can provide an inflation hedge.
What to watch a) US mid-term elections on 8 Nov: Republicans are most likely to win control of the House, if not also the Senate. A Republican-controlled Congress would constrain President Biden’s ability to respond fiscally in a recession. b) US inflation (10 Nov): at 6.6%, the consensus expects no change in core CPI from September’s 40-year high.
— Rajat Bhattacharya For Standard Chartered
