The heat has been on with central banks around the world trying to keep inflation under control. We have seen three consecutive rate rises by the RBA, the most numerous since 2010. We have observed similar monetary policy tightening action in other jurisdictions, notably the US where the last inflation read was 8.6%. Central banks are walking a tightrope as they try to manage inflation while at the same time trying to avoid a material economic slowdown.
One of the challenges is that many of the inflationary pressures we have observed have been driven by supply side issues caused by the pandemic and the subsequent pressure on supply chains. This has been coupled with the war in Ukraine which together have driven up the price of everything from building materials, food and energy costs.
There are some initial signs however that the heat may be coming off some of the areas that have been driving inflation. Globally, there is evidence weaker demand is coming through reflected in weaker PMI figures, opening up some spare capacity and allowing supply conditions to improve. Notably, indicators such as Global Manufacturing PMI supplier delivery times are showing signs of improvement, suggesting goods are beginning to move again and the S&P Global Supply Side Shortages Indicator is easing.
Other signs of the heat coming out of the economy are evident. The most visible and arguably high-profile, given many of us have exposure, is the housing sector. The Australian housing market is showing signs of softening with auction clearance rates at two-year lows according to CoreLogic data. Sydney has recorded the sharpest fall in house prices, falling by 1.6% in June. We have also seen a string of construction companies go into liquidation, the most recent being Langford Jones Homes in Victoria.
It is too early to assess whether rate rises are having their intended effect and whether central banks have the balance right between managing demand and keeping the economy growing. However, there are signs that demand is weakening and that supply chains are slowly working through the ‘covid’ backlog. If we see sustained evidence that inflation has peaked, and bond yields show signs of stability it is plausible that central banks will pause their tightening cycle and we may even see rates come back down next year. Until that time expect more bouts of market volatility as the market attempts to price in expectations on interest rates.
Considering this environment, we have sought to moderate any material asset allocation tilts and well as factor exposures within our suite of portfolios. We are likely to hold this position until we see sustained signs of inflation peaking and rate hiking cycle approach its climax. At that point we will reassess our portfolios positioning.
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