Overview

  • Inflation is proving more stubborn than consensus expected at the start of the year. The US economy continues to remain resilient and the Fed has no option but to continue with tight policy.  Clearly, the neutral rate is higher than we had thought and a recession this year is now not likely.  Policy rate expectations are better-anchored to the growth and inflation trade-off than at the start of the year.  However, this is still a difficult environment for asset allocators, so we don’t advise taking aggressive bets and have made relative minor adjustments to our allocations.

 

  • Equities have been quick out of the gate this year and the risk of a correction over the next 6 months seems high even though a recession is not likely. Rising bond yields could provide the squeeze, but like 2023 this would be more due to upward pressure on the neutral rate rather than re-emerging inflation threat.  We lift our underweight in Australia back to neutral to provide protection for growth assets if bond yields were to surge again.  Japan and Europe remain our preferred equity markets.

 

  • We move our sovereign bond exposure back to neutral because of concerns about higher bond yields. A moderate increase in unemployment is the goal of most central bankers, but it has remained elusive even though there has been some clear labour market softening.  We prefer Investment grade credit over High-yield and like global infrastructure over global property.  In defensive assets we have made room for dialing back the sovereign bond exposure by increasing the exposure to cash, given policy is likely to remain tight at least until the middle of the year.

 

  • The run sheet for central bank easing will be important for the Australian dollar outlook. The Fed looks likely to move before the RBA and this will provide support for the AUD.  So too will any upside to key commodity prices such as iron ore from better-than-expected global growth.  On the other hand, more stubborn inflation in the US would clearly be negative for the AUD.  We estimate the $A/$US is currently around fair value.
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