MacroResearchBoard

Resuming The Tightening Cycle – June 12, 2023

A just-published report updated our views on global financial markets, focusing on the evolution of the rate-hiking cycle in the developed world and the implications for bond and risk asset markets. Two of the weak link economies resumed policy tightening last week, Australia and Canada, which was a clear warning that the fight against elevated and sticky DM inflation is not over.

As we have noted in recent months, both Australia and Canada still have historically tight labor markets. While both have seen some easing in inflationary pressures from their pandemic-propelled peaks, it has not been sufficient to claim that the inflation fight is nearly over, far from it. Worrisomely for their central banks, both countries have witnessed a rebound in housing demand and home prices in recent months, underscoring that interest rates have not yet reached the choking point, despite both having unprecedentedly high household debt levels and sharply rising debt servicing burdens.

As the report concluded: “If the weak link countries’ central banks are not finished tightening, then what does that say about rate expectations in the U.S., euro area and other less leveraged, healthier economies? Answer: it is premature to position for a significant easing cycle starting late this year and throughout 2024”.

For now, we are sticking with modest risk-on positioning, but with tight stops. A downgrade in our cyclical equity weighting (currently neutral) is likely once bond market weakness gains momentum and expectations for U.S. rate cuts unwinds.