Market update: Interest rates continue to pose headwinds to the global growth outlook

Global Overview

The U.S. stock market saw a decline in the third quarter, with mounting inflation concerns impacting the outlook for sustained high interest rates. Contributing to these worries was the oil price surge, linked to OPEC’s production reductions.

Despite holding steady in its last two sessions, the U.S. Federal Reserve (often referred to as the Fed) expressed an inclination towards monetary tightening. The consistent increase in the U.S. 10-year bond yield – moving from 3.6% to 4.7% in half a year – is particularly unsettling.

The implications of a surging bond yield are manifold, encompassing elevated borrowing costs for governments, businesses, and consumers, as well as influencing the metrics for assessing growth investments. Currently, U.S. investors can acquire nearly 5% returns from virtually ‘risk-free’ cash and bonds (when held to term). This sets a new standard for alternative investments. Various factors, such as increased bond issuances, Congress stalemates, a recent dip in the U.S. credit rating, and diminished bond appetite from major players like the Fed, China, and Japan, seem to be influencing the bond yield spike.

A significant drop in growth and inflation appears necessary to reverse the trend in bond yields. Speculation arises regarding the Fed’s potential shift from bond selling (quantitative tightening) to bond purchasing (quantitative easing). Notably, similar interventions have been seen with the Bank of Japan and the Bank of England. Yet, for the Fed, a significant pivot like this likely requires a catalytic event.

While many developed nations grapple with escalating interest rates, China, aiming to invigorate its slowing economy, is steering in the opposite direction. However, China’s maneuverability is constrained due to the need to stabilize its weakening currency and avoid further inflation in its already strained real estate market.

Australia’s Landscape

Australia mirrors the U.S. in certain aspects, especially with its central bank, the RBA, maintaining rates amidst escalating core inflation concerns. Market projections suggest another 0.25% rate hike, potentially reaching 4.35% at its peak.

Although Chinese steel output remains high, bolstering commodities like iron ore and coal, the potential downside seems to be amplifying. Factors include surplus steel production and diminished profit margins. Simultaneously, increased Chinese immigration to Australia, possibly driven by concerns over governance and a weakening currency, has given the Australian real estate market a boost. Yet, this has also exacerbated core inflation issues due to housing scarcities and rent hikes.

On a brighter note, Australia boasts robust growth and job figures. The federal government’s financial health is commendable, evidenced by a $20 billion budget surplus and a Debt/GDP ratio under 40% – one of the most favorable amongst developed nations. Additionally, the Australian banking sector remains resilient regarding liquidity, reserves, and capital.

Future Prospects

With the trajectory of rising interest rates, investors find appealing yields in cash, deposits, and bonds. However, a note of caution is sounded for growth assets, given the potential deceleration of earnings growth and the strain from escalating bond yields.

These dynamics stem from the interim monetary tightening phase and may reverse as Central Banks lean towards easing, in line with waning growth and inflation. Predicting this shift is intricate, with potential for numerous premature signals.

We anticipate FY24 to present hurdles for growth assets. However, this could also pave the way for lucrative investment opportunities in quality equities, real estate, and infrastructure from a long-term perspective. It’s essential for investors to uphold diversified portfolios, recognizing that the inherent volatility in growth, income, and liquidity-driven assets, such as publicly traded securities, is part and parcel of the investment journey.

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