Exposure rates of the Dorval Asset Management Range - October 7, 2022

Despite some encouraging signs, the process of rebalancing supply and demand on the US labor market is not hasty enough to prompt the Fed into action. However, the central banks’ role is fraught by growing concerns on financial stability.

The recent slew of US economic indicators points to a continued robust economy in the country, albeit with an easing in supply-demand imbalances on the goods and services market, as well as on the labor market (cf. chart 1). Inventories are normalizing along with delivery times, while pricing pressure is lessening. Meanwhile, job openings decreased considerably in August after a slight uptick in July.

 

 

US economy: encouraging signs on the supply side, but still inadequate for the Fed

Job openings / Prices paid / (average manufacturing and services ISM) / Delivery times (average manufacturing and services ISM) / Assessment of inventories (average manufacturing and services ISM)

 

The Fed often refers to the need for these job openings to continue decreasing at a sufficient pace as a way to keep wages down. However, we note that the rise in hourly wages on average over recent months seems to have stabilized at around 4.5% on an annual basis (cf. chart 2). This is admittedly above the 3-3.5% pre-Covid increase, but it is also far short of the 6% jump witnessed at the start of the year. These figures are not reassuring enough to trigger a shift in the Fed’s stance, but they do suggest that a shift to ultra-restrictive monetary policy – with interest rates at 5% or more for example – may not be necessary to achieve the much sought-after normalization.

 

Wages growing at a faster pace than pre-Covid, but trend has eased since the Spring
6-month change (annualized)

US hourly wages

 

 

However, pending publication of the next inflation indicators, investors will continue to worry about the implications of rising interest rates for financial stability. 2022 will go down in history as the worse bond crash in modern times (cf. chart 3), due to the extent of rising yields as well as major bond price sensitivity to these climbing yields at a time when interest rates are still low (duration effect). The first signs of difficulty emerged in late September from so-called LDI funds (Liability-Driven Investment), which support UK pension funds in their asset and liability management. It is impossible to tell whether other market segments will show such serious signs of distress over the weeks ahead, but in any case, financial institutions’ risk control will most definitely step up after this episode, thereby keeping risk premia high on the markets. Investors will thus keep a very close eye on the situation in the UK, as the Bank of England had announced that it would end its operations to purchase long-dated gilts from October 14, with a significant hike in short-term rates set to follow on November 3.

 

 

Unprecedented bond market crash
Annual total return performances for Bloomberg indices (USD)

 

Against this complex backdrop, we have opted to steer clear of any positions on the bond market. We continue to clearly underweight equities in our international flexible funds, and prefer money-market holdings. We stand poised to adjust our positions as necessary to address these highly challenging markets, although opportunities will certainly materialize over the weeks ahead.

 

 

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