Dorval Asset Management’s macroeconomic & market scenario and exposure rates - November 4, 2022

Jerome Powell quite naturally remained unyielding, but the markets have now priced in most of the Fed’s expected rate hikes out to the Spring. A relative stabilization on the US bond markets along with a recovery on the Chinese markets may now therefore help fuel better showings on the world financial markets, at least for the short term.

Despite some ambiguities in the Fed’s written communications, Jerome Powell’s very resolute stance during his press conference prompted investors to further upgrade interest rate projections for 2023, which now exceed 5% (cf. chart 1). However, this movement remains limited as expectations were not optimistic. Additionally, the Fed’s communication indicates that the pace of hikes could slow slightly. Lastly, even economists – who like Lawrence Summers are in favor of very aggressive monetary policy – are beginning to make noises about a plateau of 5-5.5% for money-market rates.


Markets price in a realistic scenario for Fed funds rates by the Spring


Fed funds rates expected by the money market (source: Bloomberg)


Of course there is no guarantee that the Fed’s terminal rate will not ultimately exceed the 5.0-5.5% range, but it is too soon to speculate. An approximate stabilization on the US bond market – in a range of 4-4.5% for the 10-year – is therefore possible in the short term. Fed funds rates expected by the markets look consistent with recent economic stats that point to an ongoing robust labor market (+233,000 new jobs created in October), fairly solid consumer spending (vehicle sales recovered considerably in October) and core inflation that has stabilized at around 6.5% for consumer prices, +5.0% for the consumption deflator and +4.5% for hourly wages. However, economic momentum seems to be gradually slowing, judging by the various business climate indicators: the average of these various figures has hit its lowest point since March 2020 (cf. chart 2). Additionally, job and wage momentum is gradually narrowing e.g. the real estate and digital sectors are displaying a fairly clear slowdown.


US economy seeing gradual slowdown
Average of ISM (manufacturing & services) and S&P Global (manufacturing & services) surveys



Looking beyond the approximate stabilization in Fed funds projections, the stock-markets are also enjoying a more upbeat context on the Chinese markets. Nothing is officially scheduled yet, but China will obviously be planning for a more sustainable and less economically damaging response to the Covid-19 crisis. Additionally, several factors that have led to a collapse in Chinese share indices since the start of 2021 seem to be changing: for example, it looks like legal and accounting questions on ADR (Chinese companies listed on the US market) are now being resolved. These factors could underpin the markets right across Asia and emerging market indices (cf. chart 3).



Emerging market indices could be lifted by stabilization in China



Macroeconomic uncertainties remain high, but some recent shifts could drive a continued upturn on the stock-markets in the short term. The US bond market has adopted a realistic stance on the predictable path forward for the Fed’s rates, while many investors remain very cautious, signals out of China are taking a turn for the better, and the world economy is slowing without making too many waves for now. We have therefore upped the equity market exposure in our international flexible funds over recent days (unwinding hedges and taking out a small long position on the MSCI Emerging Markets index). However, our risk exposure remains moderate and highly diversified.



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