Macro market moves

The US Fed hiked rates by 50bps, with Powell guiding to expediency in returning to a neutral stance, as such we can continue to expect multiple back to back moves of this order/magnitude.

Mildly dovish, in fact, at the margin, given 75bps (“shock and awe”) had entered the equation, implying we might have passed some point of peak hawkishness.

We are well positioned for higher rates, having been underweight fixed income (short duration) and overweight alternatives (largely uncorrelated to rates) over the past 18 months.

We’ve been steadily narrowing this underweight to bonds, as yields rose, and are now slightly overweight for the first time in years, largely centred on an allocation to AGB’s (Aussie Government Bonds).

The Alts have largely done their job (the “real asset” infrastructure portion of our Alts exposures has solid inflation passthrough protections, and the CTA/ARP [Alternative Risk Premia] are largely uncorrelated to rates, as are the Equity Market Neutral managers we use) as such we’ve been selectively using them as a funding source.

The below graph does a good job of highlighting this low to negative correlation to flagship Alts strategies (hedge funds, long-short EMN, commodity trading advisors, direct and unlisted infrastructure and property), using asset class returns against the AusBond composite returns.

Note also that equity market correlations have risen, with bond returns, and indeed the recent sell-off in both equities and bonds has caused some to question the offsetting nature of risk in an allocation to both.

We’d suggest the primary reason for this correlation to become, and stay, positive, depends entirely on the outlook for inflation. If inflation were persistent, and remained stubbornly high, we would have a problem for the famous 2 asset portfolio (the “60-40 stock-bond portfolio”).

But we do not think that inflation will prove persistent, or remain embedded at these high levels. As such, with a positive ex ante return on bonds, and the presumption that the preconditions to keep correlations negative holds, we remain happy with the equity market risk hedge that bonds provide.

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