Key Points:

  • A global recession remains our base case next year. The world’s major central banks feel they have tightened enough for now, while the RBA still has unfinished business. There is plenty of tightening in the pipeline to slow growth next year to a point where a recession remains our base call. However, as we have
    argued it will only occur if there is a shock large enough to tighten financial conditions more broadly.

  • The Fed and US growth outlook is mostly in the price now, but we think it is still too early to raise our small overweight on sovereign bonds in preparation for recession. Both short-rate expectations and the term premium have risen enough given the growth and inflation trade-off. However, the inflation war is not won as the RBA discovered after 4 months of keeping policy unchanged. There is still a risk the major central banks may need to take out more insurance. The RBA has a short-term tightening bias that may be extended into Q1 next year, while the Fed, ECB and BoE are not likely to change policy over this period.

  • We retain our slight underweight to Growth and Defensive assets and retain our significant overweight to Cash. Cash rates may be near their peak, but cash offers a good risk-adjusted return when there is lingering downside risk in bonds and an unclear line of sight on earnings over the next year. We also like Alternative assets, given there is little conviction either way on the major asset classes. The main change in the equity mix is that we take profit on Japan. Europe is now our equity market.

  • The Australian dollar has rallied sharply in the past few weeks due to the widening interest rate differential between Australia and the US. We estimate the $A/$US is currently around fair value, but we expect it to depreciate next year to around 4US0.60 as global growth slows.

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