Threading the Monetary Policy Needle: January 24

Australian and Global Equity Markets rose in January, with the S&P/ASX 300 gaining 1.2% CYTD (7.1% 1-Year Return) whilst the MSCI World Index rose 1.8% over that same period (18.3% 1-Year Return), continuing 2023’s year-end ‘Santa Rally’ which caught many market forecasters by surprise (Chart 1). These headline figures mask some significant intra-month swings: in January, the Australian Equity benchmark fell approximately 3.7% and subsequently rallied 4.5% to near all-time highs.  Government bond yields mirrored equity market prices, with the Australian 10-year government bond yield initially increasing to 4.3% and finishing the month at 4.0%. Similarly, the US 10-year government bond peaked near 4.2% and finished at the month at 4.0%.

These gyrations appear to stem from the improving inflation situation (enabling lower rates) working against seemingly robust job markets and hawkish communications from key central bank figures (implying higher or steady rates).

Starting with employment figures: the December Australian unemployment rate remained unchanged at 3.9% and the US JOLTS Job Openings survey (a leading US unemployment indicator) surprised to the upside, ending a multi-month streak of falling job openings. However, looking through the headline figures, there are signs of cooling within the jobs market – the Australian participation rate fell to 66.8% whilst BCA research notes that hiring in the US remains in a downtrend and below pre-pandemic levels.

Australia’s latest inflation figures for the December 2024 quarter (Chart 2) show annual inflation falling to a two-year low of 4.1% – below economists’ predictions of 4.4%, and closer to the RBA’s 2-3% target. 

Market participants now anticipate that both the RBA and the US Federal Reserve have completed their rate hiking cycle, having previously expected that Australia’s inflation situation could require rates to remain elevated for longer. The question for investors is now when, not if, central banks begin to cut rates. Still, central banks must carefully thread the needle on rates in order to support the economy without stoking inflation. The RBA is expected to leave the policy rate unchanged on Tuesday but to strike a dovish tone at its first press conference since the Chalmers review. Meanwhile, the Fed has downplayed the possibility of rate cuts in the first quarter, noting that inflation remains outside its target. The next key US data release will be Friday’s non-farm payrolls report.

The Australian Dollar Remains Buffeted by the Chinese Economy

Heading into 2024, the Australian dollar strengthened, aided by rallying Iron Ore prices off the back of Chinese steel demand and the expectation of a sustained rate differential between Australia and the US. However, this latter thesis was weakened Australia’s lower than expected December inflation figures. Simultaneously, iron ore Prices (Chart 3) fell from a high of 144 USD/mt in early January to close the month at 135 USD/mt – a 6.2% fall in a matter of weeks.

According to Daniel Hynes, senior commodity strategist at ANZ, falling iron ore prices stem from falling Chinese Steel demand as evidenced by iron ore stockpiles rising for a 6^th straight month in January. Chinese factory activity exhibited ongoing weakness in January with Chinese Manufacturing PMI coming in at 49.2 which indicates contracting factory activity. Furthermore, China’s real estate sector troubles continue: Nomura estimates that at the end of 2023, 20million pre-sold apartments were late or abandoned. Despite this, the Chinese government appears reticent to implement significant stimulus measures. Capping things off, Evergrande, the exemplar of China’s property woes was ordered by Hong Kong’s high court to be liquidated and broken up.

Portfolio Positioning

The last quarter of 2023 featured an equity market rally that almost no one saw coming and capped off a year that started with dismal economic and equity market expectations. By contrast, 2024 began with far more bullish economic forecasts building off the end of year momentum. What the year has in store only time can reveal, but January’s equity, bond, and currency swings neatly encapsulate that a good investment destination may involve a very unpleasant journey.

LBP maintained its defensive positioning for the first quarter of 2024, remaining moderately underweight equities and other growth assets, with a higher allocation to private debt, fixed income, and cash for dry powder should attractive opportunities arise. In January, despite some volatility, markets largely continued the 2023 year-end trends whilst current Monetary Policy uncertainty and ongoing challenges within the Chinese economy support our defensive stance.

In your quarterly reports you will have noticed that LBP have updated our Asset Allocation framework to more explicitly recognise that asset classes exist on a risk spectrum, with varying and overlapping contributions to portfolio risks and return. For example, we now classify Private Equity as a subset of Equities more broadly where most allocators still consider this asset class ‘Alternative’. The updated framework does not currently impact any of your portfolio positioning, but LBP expects this change will enhance the risk/reward outcomes of asset allocation decisions going forward.

Exposure to great investments is only half the battle. Having an investment portfolio aligned to your long-term risk capacity and remaining invested is the other. Fundamentally, capital markets deliver positive expected returns over the long-run for bearing various risks – LBP designs portfolios to gain robust, diversified, exposures to these compensated risks and help you remain stay invested through short-term volatility.