Reality of rate rises hit home

16 March 2018

House View

Mark Rider explains clearly emerging risks to the world’s growing economy as policies take effect.

A major change in market sentiment over recent weeks has been an acceptance that the US central bank will raise rates possibly four times in 2018, while Europe will gradually reduce its economic support measures.

This is of critical concern to investors, as rates have been so low for so long, stimulating the economy, that fears are now building over the effect of gradually reversing that policy. This fear has been escalated by the prospect of much larger US fiscal deficits (despite the US economy growing well above potential) that have to be funded.

While the correction has eased valuation concerns, it hasn’t been enough to really correct growing risk in the market. Three key issues weighing on markets are that:

  • share valuations continue to look expensive particularly in the US
  • the US fiscal deficit has widened sharply despite the economy being fully employed and growing well above potential
  • policy measures such as steel and aluminium tariffs will likely add to cost pressures and heighten policy uncertainty.

And these risks are adding to inflation pressures. Strong global economic growth is already leading the world’s central banks to possibly more rapidly reduce economic stimulatory measures and recent policy moves are adding impetus to this trend.

ANZ investment strategy – March

It’s from the view outlined above that we form our investment strategy, which is underpinned this month by two central observations, that:

  • growth remains above trend (with most major economies continuing to perform well)
  • we have entered a period where rates can be expected to rise as central banks start to remove extreme policy support. 
Asset class Position relative to benchmark/outlook1 Reasoning
Growth assets Neutral  
Australian equities Neutral Expected to continue to deliver reasonable single-digit returns. Share valuations are at upper end of fair-value range.
International equities Neutral Returns will ease as rates rise and be a headwind to solid earnings growth.  Most markets are above our fair-value range.
United States Neutral
Europe Neutral
Japan Neutral
emerging markets Neutral This asset class has delivered strong returns, but concerns that slower growth in the Chinese industrial sector in conjunction with gradual Fed tightening will become headwinds in the year ahead.
Listed real assets2 Neutral Real estate markets and infrastructure have corrected lower as yields have risen. Values are fair. Earnings consistent.
Defensive assets Neutral  
Fixed income Underweight  
       Australia Neutral Inflation pressures have remained subdued with little pressure to tighten policy. Given high quality of markets and yields being above most markets we expect markets will be supported.
   New Zealand
   international Underweight Inflation pressures are building and we expect rates to steadily track higher.
Cash3 Overweight  
AUD/USD Neutral The Australian dollar is currently around fair value and supported by a synchronised lift in global growth. We expect that growth will ease, and with the RBA only tightening slowly yield support could erode.
NZD/USD Neutral  
USD TWI Neutral  

1. Equities, fixed income and cash are relative to benchmark. Currencies are relative to an absolute return outlook (short term).

2. Comprises of 50/50 split between GREITs and infrastructure securities.

3. Cash is the balancing asset class. Cash is a residual to portfolio manager’s overall implementation of other asset class strategies. It continues to form part of the overall defensive asset allocation, with PMs having flexibility in terms of how to implement the stated defensive asset strategy across fixed income and cash. In the RIC model cash overweight to facilitate an underweight position we hold in international bonds and to manage overall fund duration.