Doves have flown the coup

The stagflation narrative was amplified in April as inflation pressures increased and economic activity around the world was much softer than expected. Meanwhile in the background, central banks continued to ramp up expectations for bigger jumps in official policy rates as they sought to stamp out the inflationary fire. The increase in bond market volatility transferred to the equity market, leading to heavy selling pressure in developed markets.

Equities were hamstrung by the conflicting forces and developed market equities declined by 6.9% in April. Emerging market equities performed better with a -3.5% return. Fixed income returns were similarly bleak, the Bloomberg Barclays Global Aggregate index fell by 5.5% over the month. Cash outperformed most major public markets with a flat return in April.

There are few, if any, doves left at the major central banks as board members prepped the market for larger rate hikes at May meetings. The mix of elevated inflation and rapidly tightening labour markets is generating some urgency for central banks to normalize policy settings. This has increased expectations for the U.S. Federal Reserve (Fed) to raise interest rates by 50bps at subsequent monthly meetings, but also further rates hikes from the Bank of England, and for the European Central Bank to start on its rate hiking cycle in the coming months. The Reserve Bank of Australia (RBA) is not being left behind. The exceptions of the Bank of Japan and the People’s Bank of China were that inflation pressures and the economic outlook warrant still loose monetary policy settings. The division in policy settings between China and Japan with the U.S. has resulted in a depreciation in both the Chinese yuan and the Japanese yen.

This comes at a time when economic growth has experienced a sharp downshift. The U.S. economy contracted by 1.4% on an annualized basis in the first quarter, while the growth figure from the eurozone was also soft. Chinese data from March is starting to illustrate the impact of the lockdowns which extended across the country to control the spread of COVID-19. Meanwhile, the closely watched Purchasing Managers Indices for April suggest the economic soft patch has carried over into the second quarter.

However, it is likely that the economic expansion has been dented rather than derailed and is far from recession in the coming 12 months. The broad support from consumer and corporate activity should support the economic outlook throughout the rest of this year. 

Economy:

• The RBA raised interest rates at its early May meeting by 25bps to 35bps and highlighted a need for further rate hikes to tame the 6% inflation rate it expects for 2022. We expect further rate hikes in June and August and that the rate hikes penciled in for 2023 to be brought forward given how far the cash rate is from the estimated neutral rate.
  (GTM AUS page 53)
• The unemployment rate was steady at 4.0% in March, a bit higher than expected. Employment grew by a modest 18,000 jobs but was driven by full-time employment.
  (GTM AUS page 8)
• Headline CPI for 1Q22 was 5.1% year-over-year, and the biggest jump since the tax-induced move in 2000. Australia’s inflation rate had lagged other developed markets, but the 1Q22 figures illustrate that no country is immune. Energy, food and housing costs (as the HomeBuilder subsidy fades) were the biggest inflation drivers.
  (GTM AUS page 7)
• Campaigning for the Federal election began in April and polls show a close race and the prospects of a hung parliament cannot be ruled out at this point.
• Business survey data, such as the Purchasing Managers’ Index for manufacturing dropped in April. While the global index remains in expansion territory at 52.2, the output sub-index has fallen to 48.5, signaling an upcoming contraction in activity. Meanwhile, delivery times have been extended as supply chains remain under pressure.
  (GTM AUS page 15)

Equities:

• Australian equity market performance was tested in April but managed to outperform other developed markets. The ASX 200 fell 0.9% in April, much better than the 8.7% decline in the U.S S&P 500, where the higher weight to growth sectors dragged on performance.
  (GTM AUS page 33)
• At the sector level, utilities gained 9.3%, making it the strongest sector, followed by industrials (3.5%) and consumer staples (3.3%). At the other end of the spectrum were IT (-10.4%), materials (-4.3%) and consumer discretionary (-3.1%).
• The earnings momentum from the resource sector has helped the overall index, and the price-to-earnings ratio of 14.8x is line with long-run average.
• The U.S. first quarter earnings season is well underway and at the time of writing, 75% of the S&P 500 by market capitalization have reported. Earnings have been mixed, with some notable misses amongst large tech and consumer services companies. Year-over-year earnings are still expected to be in the high single digits, and margin pressures have not been as strong as feared. Those companies missing analyst expectations for earnings and revenues are being penalized much more than those beating expectations.

Fixed income:

• The bond market saw material moves through April and the yield on Australian 10-year government bonds rose by 30bps to 3.12%. The U.S. 10-year Treasury increased by a greater 56bps to 2.89%. The movement in bond yields were driven by increasing inflation fears and the hawkish rhetoric from central banks as markets priced for more aggressive policy tightening.
  (GTM AUS page 50)

Other assets:

• Commodity price movements were relatively muted compared to the shifts in stocks and bonds. The price of Brent oil was up by USD 1 to USD 109 per barrel. Weaker demand prospects from China helped to contain the price even as Europe continues to work toward reducing its reliance on Russian energy.
  (GTM AUS page 62)
• Meanwhile, the price of iron ore was unchanged at USD 151 per ton as the economic restrictions in China weighed on steel demand and production was disrupted.
  (GTM AUS page 64)
• The gold price succumbed to the prospects of positive real rates as the U.S. Fed stepped up the policy tightening. Gold fell USD 31 to USD 1,911 an ounce.
• The U.S. dollar gained against all major currencies over the month, given both the safe haven buying and the policy divergence. The Australian dollar fell by 5.4% against the greenback. The Japanese yen depreciated by a larger 6.3% and the euro fell by 5.2%. The broad-based dollar index was close to a 20-year high by the end of April.