House Views - October 2022: Rates tighten
The rise in yields has gathered pace in the last few weeks. And unlike other rises of recent years, it is not being driven by a stronger growth outlook but by a tightening of monetary policy to deal with inflationary pressures. The jump in yields – both nominal and real – has turned up the pressure on developed economies.
Higher rates squeeze activity by making refinance costlier. Real estate and corporate investment alike are set to slow sharply. Central banks are tightening financing conditions in order to stem inflation, but this also heightens the risk of recession. US interest rates have risen particularly steeply. In Europe, the hikes have been less spectacular but the economic agents they target are already reeling from the energy crisis. For many countries, the rise in rates further complicates their economic policy decisions. For one thing, the steeper hikes in US rates have added to pressure on currencies, forcing various central banks, particularly in Asia, to intervene. For another, higher interest rates are undermining European governments’ plans for large-scale measures to mitigate the impact of the energy crisis by automatically increasing their funding costs. It was the difficulty of getting the right mix of monetary and fiscal policy in these circumstances that underlay the disruption in UK financial markets over recent days.
Further retrenchment of our investment strategy. We are doubling down on our prudent approach to equity markets by Underweighting nearly all regions and maintaining our ample allocation to defensive and resilient sectors. At the same time, we are adding to our bond market positions, moving to Overweight on United States fixed-income markets. In our view, US bonds are now offering attractive returns, particularly in real terms. Redoubled prudence is also why we are cutting our oil exposure and bolstering our position in the Swiss Franc. Finally, we are taking a defensive view of the pound sterling given the turbulence rocking UK markets, which could continue for some time.