Market Commentary: Has inflation peaked? | What’s happening to global bonds?

22 April 2022

Watch Freddy Lim, co-founder and CIO, Philipp Muedder, Head of Financial Planning, and Stephanie Leung, Group Deputy CIO, discuss the latest global events and their potential impact on the markets and on our investment portfolios.

In this episode:

  • How do interest rate hikes fix inflation caused by supply chain issues? (0:11)

  • Why do interest rate hikes make consumers spend less? (3:05)

  • What's the StashAway Risk Index (SRI) and what's behind the performance of our lower SRI portfolios? (6:14)


Philipp | 00:01

Hello and welcome everyone to another Market Commentary from StashAway. With us today, our Deputy CIO, Stephanie. Stephanie, how has it been going?

Stephanie | 00:09

Good. How are you?

Philipp | 00:11

I'm good. For everyone, before we actually started the recording, Stephanie said she's able to go back to the gym and things like that. So, I know she'll be in a very good mood today, so that will be good. So, things are improving everywhere in the world, hopefully with COVID. But we want to focus on a few questions that we got today from our audience, Stephanie - and something we've been talking about obviously for quite a few weeks now. And still the topic of inflation always comes up, right? Because I think there was a new record in the US again a couple of weeks ago. I think, you know that feeling in Europe is not getting any better because I think for the first time, my dad mentioned in Germany, huge price rises were happening in the grocery stores for the first time in years last week. I think around 15% to 20%, that's pretty big. So the first question that we got from our audience last time was, if inflation is due to supply chain issues exacerbated by the invasion, how will hiking interest rates fix these issues? Because we talked a lot about what the Fed is doing and if you raise interest rates - why does that go against rising inflation? How does it keep it in check? Maybe you can explain that a little bit with a bit more background for everyone.

Stephanie | 01:32

Yeah, that's a great question because the inflation that we're seeing, a lot of that is driven by rises in commodity and oil prices. And if you think about what's driving that, a lot of that has to do with, of course, in the short term, what's going on in Ukraine and the Russian invasion and concerns around supply chains, etc. So that's what we call supply-pull inflation. So the question is absolutely correct, if it's a supply-pull inflation, just raising interest rates alone will not solve the problem. The problem is that you have to increase crop production, you have to increase oil production. You have to resolve supply chain issues. However, if you look at inflation beyond the supply chain, there's also some demand-pull inflation. If you look at the numbers, for example, the US economy is very, very strong. And given that the Fed has actually pumped a lot of liquidity into the system since COVID, US consumers are very cash rich and they are able to buy a lot of goods. And these are big items like, for example, we've seen in the past year, car sales going higher, car prices going higher, home prices going higher. So these are what we call the demand-pull inflation. So the Fed raising interest rates would at some point kind of temper this demand-pull inflation and bring the overall inflation number down. So the Fed is trying to address part of the equation, but the other part of the equation...

Philipp | 03:05 

Let me ask you, because I think a couple of listeners will probably ask that question as a follow up after you just said this - so, if the Federal Reserve then raises interest rates, why does it make the consumer want to purchase less?

Stephanie | 03:17

Yeah, that's a good question. Basically the Fed - by raising interest rates - raises the price of money. So, for example, if you're borrowing to buy a house, it's more expensive to finance that house purchase, the same for a car purchase. So then it makes it a lot more difficult for people to spend money and that kind of suppresses demand in that sort of way. So, it's a very, very direct way for the Fed to temper demand. Now, having said that, I think you're right Philipp to mention that inflation, US CPI reached 8.5% in the last print. That was the March print and I think if you read the headlines, it was the highest inflation number ever printed since 1981. So like 30 years or 40 years ago. And interestingly, the market actually didn't react that badly to it. So, I mean, bonds actually gained, so yields actually came down after the number was announced. So you need to look at it one layer deeper. And if you look at the core inflation, the headline inflation includes very volatile components like energy and food, but the core inflation number actually strips out these. And the Fed actually focuses on the core inflation number because core inflation is what is more sticky, more long term, and this is what the Fed can really target. This is what I was referring to as the demand side inflation. So in March, actually, the core inflation number came in below expectation. And I guess there are some signs that point to a peaking out of the inflation number going forward. So that's why the bond market is actually quite welcoming that CPI print. If we look at, for example this chart, we can take a look at what is going on kind of on a subcomponent basis. So as you can see, the pink line is actually the headline inflation. The yellow line is the core inflation. And this is a Bloomberg estimate - if you look at some of the other sell-side estimates they point to, again, a peaking out of the headline inflation numbers right around March and April. However, even though we're seeing a peaking out in the short-term numbers, it's quite likely that we're going to end the year with a fairly high inflation number. So roughly kind of like 5% to 6% for a headline and maybe 3% to 4% for core. And this is what the Fed has projected, has been baking in their projection as well. So we're going to continue to see, I guess, interest rate hikes from the Fed. But also there could be some kind of reprieve from the short-term interest rate markets given that a lot of that rate hike has been priced in.

Philipp | 06:14

Thank you so much for explaining this, Stephanie. And I think the example you gave also with rising mortgage rates or car loan prices, I think we're already seeing this. I was talking to some friends here in the US as well as in Germany as well who are in the mortgage market. And mortgages went from last year, I think I refinanced at 2.75% for a 30-year mortgage. They're close to over 5.5% now. So the purchasing power directly impacts that, right? So people will not be able to afford the same amount for the house that they had before. So I think that really puts it in perspective. So let's move on then. And we got a second question as well that's been raised quite a few times. And the person is asking about the performance of our lower risk, especially like our SRI 6.5 portfolio, so the lowest risk portfolios. He has noticed that sometimes it loses based on when you look and what your time horizon is, but within a one-year period, it's been down more than 6.5%. So maybe we can actually talk about what SRI is again and why can it breach it and why not? And maybe the surroundings about it?

Stephanie | 07:26 

So SRI stands for StashAway Risk Index. And for those listeners who have been with us for a number of years, you may be quite familiar with it. Basically, it's our measure of risk for our clients. So we basically built portfolios around what is the risk tolerance of each individual client. So for example, the SRI is mathematically a 99% VaR of a particular portfolio. VaR refers to value at risk. So basically what we've done is that for each portfolio, we've calculated the probability over a 12-month based time frame of a maximum drawdown, i.e. from peak to trough, the maximum percentage given a 99% probability. So I'll give you an example to make it easier to understand. So, for somebody who has a moderate risk tolerance, he or she may choose a 20% SRI. And the portfolio is managed such that under different economic situations, there's only a 1% chance that the maximum drawdown would exceed 20%. So, this is a mathematical calculation. And of course, we have done a lot of backtesting and also in real life. Since we've started portfolios, the chance of breaching that SRI has been very, very, very low. And I guess what we've seen in the past few months is a very, very significant decline in bond prices given the interest rate environment and inflation environment that I talked about. So just to give everybody a bit of a context, if you look at this chart, this actually shows you the Bloomberg Global Aggregate Index. So aggregate index refers to basically a broad index for bonds. And at the bottom of this chart, you can see red patches. So these are actually drawdowns of this bond index. So if you look at the right hand side, that's current. So the current drawdown of this very broad bond index has been north of 12%. And the last time we had such a worse drawdown was actually 2008. So actually in the past 3 months, bonds have witnessed a very, very significant market price decline similar to what they experienced in 2008. So hence, if you look across our portfolios, the lower risk portfolios actually suffer because of the allocation to bonds. However, I think given what we've discussed about inflation, because interest rate markets actually move on expectations of growth and inflation and the bond rout was actually driven by very high short term inflation expectations, basically expecting CPI to go to 8.5% for example. So if we actually see CPI numbers actually start to peak out and come off, I think we can see some kind of reversal of what has happened and that would support bond prices - starting from the short term. But that would just kind of, I guess, gradually broaden out to a longer term.

Philipp | 10:50

Absolutely. Well, thanks for explaining this and answering that question, Stephanie. Let's move on to the last topic we wanted to discuss. And I think earnings season has been kicking off, right? So big companies have announced earnings just earlier today at my time actually, Tesla announced their earnings as well with record sales and record revenue. What else have you been seeing? Is this a trend of great earnings this season between the US and the European markets? Do you see any divergence there? And what's kind of your take on that? Because I think Apple is reporting this week as well, right? And there's some other big ones coming. So, what's your take on all of that?

Stephanie | 11:34

So I guess needless to say, the market is actually quite nervous because in the past few months we were in a risk-off environment. And if you look kind of underneath the bigger index, a lot of like medium cap or small cap stocks, especially tech stocks, have fallen 40% to 50%. So I think that explains, for example, why when some of the big caps missed they went down a lot - like Netflix actually reported and they missed both the numbers as well as guidance and its stock was punished down like 30%+. But if you look across different markets, the US earnings season so far, it's in the initial stages, but it's kind of quite strong - record earnings, record margins. If you look across the continent, it's not the same case. European earnings have also been coming in and it's been affected by not just the war in Ukraine and rising costs, but also because a lot of European companies are export companies. I mean, they are affected by all these supply chain constraints. And, of course, a lot of lockdowns are happening in China as well. So, I mean, it's not as good as in the US. So these are different things to watch out for. But European earnings are a big concern.

Philipp | 12:52

Thank you for that overview. And we'll keep monitoring this. And obviously when we speak again in a couple of weeks time, I think we got a lot of other companies' earnings calls behind us. So we'll get a little bit more of an inside view also on how supply chains are looking for the rest of the year. So thank you so much for this, Stephanie, today. For anyone else, we have a couple of events coming up for our Malaysian audience. So if you want to join us for those, there's a Personal Finance Basics webinar. That's Wednesday, the 27th of April at 6 pm local time. And we also have an Investment Basics webinar Wednesday, the 4th of May 6pm as well. The links to sign up for those are in the show notes as always, as well as on all of our social channels or anywhere else you can find out about StashAway. With that being said, I wish everyone a good rest of your week and speak to you soon again. Bye-bye.

Stephanie | 13:46


Stephanie and Freddy, StashAway Investment Office

Freddy Lim and Stephanie Leung

CIO Office

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