Market Commentary: Fed’s largest rate hike since 2000 | Will China retract its COVID-zero policy?

06 May 2022
Stephanie Leung
CIO Office

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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 markets reacted to the Fed’s rate hike [0:23]
  • Will the bond market stabilise? [2:57]
  • Will China choose economic growth or zero-COVID? [5:51]
  • How a strong USD affects your portfolio [8:58]


Philipp | 00:01

Hello and welcome everyone to another StashAway Market Commentary. With me today, of course, our Deputy CIO, Stephanie. Stephanie, how are you doing?

Stephanie | 00:09

I'm good. How are you, Philipp?

Philipp | 00:10

I'm very well. How is Hong Kong doing these days?

Stephanie | 00:15

It's getting slowly but surely back to normal. So today, a restriction on mask-wearing for exercising outdoors has been lifted. No masks for running.

Philipp | 00:23

That's really good. It's getting hot, too, right? So, that's good, yeah. Everyone, we have obviously lots to talk about since 2 weeks ago, we were actually anticipating today. We're recording this on the 5th of May, Asia time, and what happened overnight was we had the Fed make their statement and hike interest rates overnight by 50 basis points. So, Stephanie, with that being said, do you want to explain a little bit about why they are doing it, kind of what the language was? And obviously, we saw during the US hours, as soon as the announcement was made and Chairman Powell was giving his remarks, markets shot up to its best days since November 2020 in the stock market. So maybe you can give us a little bit of more background on all of this?

Stephanie | 01:21

Yeah. I mean the market has been extremely choppy. So I think the starting point was a very, very, I guess, kind of an oversold market. And if you just kind of zoom out a little bit, you realise that actually it just did a round trip in 2 weeks' time. Just a bit of background or kind of taking a step back as to what the Fed did. Overnight there was a 50 basis point rate hike announced and that was, I think, the first time we've had a 50 basis point hike for a long time. However, the reason why the market actually reacted quite positively to it is because it was well telegraphed and it was actually well predicted by the market and because actually there are instruments that are tradable on the market that basically asset managers use to kind of hedge or bet as to how the Fed path is going. And I think even before the Fed hiked 50 basis points, the market was already looking for a hike to almost a kind of 2.8% or 3% by the end of the year. So a 50 basis point hike was very well expected and the Fed just delivered that and they didn't go overly hawkish in the remarks. So markets, of course, have a tendency to be quite choppy when there's uncertainty but when certainty comes in and in this case, I mean, the Fed kind of delivered what the market was expecting, then the market basically settled down and reacted nicely to it.

Philipp | 02:57

Did you see the same thing happening or what's happening in the bond market? Because obviously this year has been not what people, when they look at their diversified portfolios in general, right? They say like a 60/40 equity bond portfolio is also down quite a bit because bonds have also been selling off since the beginning of the year. So it's a unique way to look at things. So with the rate hike, what's the bond market telling you?

Stephanie | 03:22

Yeah, I mean, if you look at bonds, a lot of people may not notice, but adjusted for volatility - bonds actually are the worst performing asset class this year, even worse than stocks. The reason for this, of course, is because of inflation. And given inflation, the Fed has to hike rates and when yields go up, bond prices come down. So if you look at, for example, what Philipp mentioned, like a 60/40 portfolio or a risk parity portfolio, i.e. kind of asset allocations between bonds and equities, the drawdown was actually very, very significant to the tune of – actually if you look at risk parity funds, they were down almost like 19% to 20% and this was on the same scale as COVID. So it was a really, really big shock. Of course, if you look at the markets right now, the bond market is pricing in a 3 percentage point hike towards the end of the year. But if you look at 10-year bonds, it's also close to 3%. So, the yield curve is actually pretty flat. And secondly, if you think about - how high can yields actually go further? There are a few indicators that you can look at. For short-term yields of course, it's kind of the neutral rate that the Fed has been referring to. And for people who actually have not heard about the neutral rate. The neutral rate is basically an estimate by economists and by the Fed as to the rate at which the Fed will not be expanding or contracting the economy. So basically, think about it as a target rate for the Fed to hike to. And the Fed actually publishes this during the minutes and the meetings. And right now, I mean, that neutral rate sits around 2.6% to 2.8%. So the Fed basically will hike to that neutral rate by the end of the year. Secondly, if you have to think about longer-term bonds. So for example, 10-year bonds, like what is their fair value or where should it settle? You can also look at longer-term inflation expectations. So right now, long-term expectations are also sitting around like 2.5%. So given that the market or 10-year treasuries are trading close to 3%, again, it's quite well priced in. Hence in recent weeks, we've actually seen some stabilisation in the bond market and I think that is kind of a requirement for asset prices or for asset classes to actually start to stabilise.

Philipp | 05:51

Yeah thank you, Stephanie, because you kind of already talked about my next question which was, what's next for the Fed? And I think you kind of already told us this with this neutral rate. So I think that's great. So then let's move on from the Fed, we talked about it a couple of weeks ago as well. But I think it's good to rehash and see where the situation is at this moment. Obviously, a few things happened in China, right? They also talked about the rates. We also still have a lot of lockdowns and productivity in factories are down and also at ports, right? Which obviously just exacerbates the current world situation of this whole inflation part, right? Because things are not moving, things are not coming, people are waiting for products. People are waiting so this drives product prices a lot higher. So, any update on this and where do you see this going over the next few weeks or months?

Stephanie | 06:48 

Yeah, I guess staying in Hong Kong, like a lot of other cities in China, particularly the coastal cities, the big cities in Shanghai, Beijing, they're going through what we went through in the past 3 months. And basically you see lockdowns in all these major cities. Again, as Philipp said, the blocking of major trade ports and really I mean, I guess the bigger impact is that it stops economic activities in China. So if you think about the Chinese policymakers, they have a very difficult choice because the stated goal for this year is to have a 5.5% GDP growth, but they also have another goal of reaching COVID-zero. And these two targets are not really compatible with each other with the recent COVID outbreak. So I think ultimately, something has to give and we've seen some signs. For example, the week before, there was some loosening and there were some rumours about relaxing restrictions on Internet companies etc. So perhaps the policy choice for them is to relax or stimulate the economy a little bit so that it doesn't go into recession. But we'll have to see because we haven't seen a very strong policy reaction. And I think the third goal, which is a much longer-term goal, is for the Chinese economy to deliver. So we won't see a big style stimulus because that would contradict with the longer term goal as well. So having said all of this, of course, because the supply chain is blocked so it pushes up input prices, etc. But there's also a silver lining to this because the Chinese economy is basically going to suffer in Q2 because of all these lockdowns. And if you think about a kind of deflationary force, this will be one big deflationary force globally. So it actually may help the US from the inflation front or globally from the inflation front.

Philipp | 08:58 

Yeah, that's a good point of view. I liked that, let's see how it plays out and we'll definitely be monitoring this, but I liked that point of view that's a little bit different than everyone else. So I liked that. Last but not least, Stephanie, obviously this year showed again the strength of the US Dollar when it comes to turbulent times, right? Now the US Dollar is at all-time highs, pretty much against most currencies I think, except the Brazilian currency as well as the Russian currency by now which is funny because we were just talking about this before offline, how the Ruble has recovered. It's literally like this was the charge, right? Literally goes up and goes right straight down. But with the US Dollar at an all-time high, what's your view on this and what's the impact on people's portfolios as well, right?

Stephanie | 09:51

Yeah, I think the Ruble is a very specific case in which basically, Russia tells everyone to buy the oil and gas in Ruble. But if you look across all the major currencies, they all weakened towards the US Dollar and actually the US Dollar versus other currencies is at multi-year highs and most recently even Renminbi, which has been strong, has started to depreciate. And I think given the volatile kind of macro environment, the US Dollar is traditionally still serving as a safe haven currency that people would gravitate towards. So it actually shows the benefit of having diversification away from your home currency during these turbulent times, actually having a US Dollar exposure helps to offset some of the drawdowns in assets and helps to stabilise your portfolio. So again, let's watch how the macro unfolds. But remember to have a diversified portfolio of currencies and also asset classes to help you to navigate through these difficult times.

Philipp | 11:06 

Yeah, that's great advice. Thank you, Stephanie. And for everyone else, we have a few events coming up in Malaysia as well as in our MENA region. And the first one is in Malaysia, that's called How to Invest (The Right Way) with ETFs. That's Wednesday, the 11th of May, 6pm local time. So if you want to sign up, as always, there's the links in the show notes below and you can also find them on our website and everywhere else we interact with us. And for our MENA region, we have a pretty exciting chat there. It's called StashAway Money Chat. It's called How Financial Education Can Lead to Financial Freedom. That's again on Wednesday, 11th of May, 6pm local time. So we're looking forward to seeing as many of you as possible there. Stephanie, I wish you a wonderful day ahead and we'll speak again with everyone else in a couple of weeks. Thanks so much.

Stephanie | 11:56

Thank you.

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