In this month’s strategy piece Alastair George believes that the prospect of a prolonged period of tighter US monetary policy has led to a soaring value of the US dollar and one of the largest sell-offs in global government bonds in the modern era. There are also specific ‘pinch points’ in the investment landscape acting as focal points for market volatility, with the UK being the most recent example. Over the summer, the talk was of inflation and rising interest rates, while during autumn it has shifted to financial accidents. In a strange way, this represents forward progress as the latter typically follow the former. While the surge in inflation in developed economies has been extraordinary, the surge in interest rates is similarly off the scale and we believe the necessary slowing of the global economy is already underway. We continue to believe that the ‘financialisation’ of the global economy has only increased the potency of higher rates on economic activity. On both sides of the Atlantic, short-term rates have risen by more than 1% in a matter of weeks. We expect the slowdown in the economy to accelerate, easing inflation concerns but adding the risk of declines in earnings forecasts. We remain neutral on equities but with a positive bias following the recent market declines. Resilience should be the watchword for equity holdings. Business models should be strong enough to buffer the impact of declining growth even as input costs continue to rise. Balance sheets need to be sufficiently robust to handle any potential shortfall in revenues and significantly higher corporate funding costs. We remove our underweight on bonds with US and UK 10-year yields breaching 4%. If growth slows and inflation declines as we expect, provided fiscal discipline is not called into question bond yields now appear to discount the coming period of tighter monetary policy and should decline as the growth slows and the yield curve inverts during 2023.
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