With China poised for an upswing in growth and Europe closer to an inflection point, CIO suggest looking beyond the US for equity exposure. (ddp)

The Fed's rate path has re-emerged as a primary risk driver for markets.

  • From mid-2022, futures markets had consistently priced a lower terminal rate than the Fed's own base case—putting the peak at 4.8% in early February.
  • That's since risen to as high as 5.44%, following a raft of inflationary data points, pressuring many financial assets.
  • In February, the DXY and UST 2-year yields rose 2.7% and 59bps, respectively, while the Bloomberg global agg bond index fell 3.3%.

And it's not the only risk investors need to keep an eye on.

  • Risks like a spring escalation in the Ukraine war, which has already reconfigured global supply chains and disrupted energy sales, could revive commodity volatility.
  • US-China relations could worsen over tech export controls, Taiwan, and Russia policy, or fallout from the air balloon incident.
  • US domestic pressure is mounting too, with a partisan showdown looming over the debt ceiling and the federal budget.

With the jury still out on the US economy, investors should re-examine their portfolio exposure.

  • We think investors can look beyond the US, with momentum in China and Europe suggesting better performance from EM equities and markets like Germany.
  • Value stocks, including the energy sector, should be relatively resilient amid high inflation, while consumer staples offer some defensive exposure.
  • The inflection in central bank policy has been delayed, not derailed. We like high grade, investment grade, and EM bonds.

Did you know?

  • As of February, futures markets had priced a lower peak Fed terminal rate than the Fed's own central case scenario for at least six out of the previous nine months.
  • Oil prices have fallen some 30% from their peaks, creating supportive base effects that mean headline inflation will soon fall well below “core” readings that exclude food and energy
  • Despite a raft of US rate hikes and macro headwinds, US two-year inflation expectations have crept back above the 3%mark.

Investment View

We suggest a selective approach to risk, with a geographic tilt away from US equities and growth, and more defensives sector exposure like consumer staple. Investors may seek some portfolio insulation from choppy equity and bond market conditions via selective hedge funds, while energy exposure could help hedge some geopolitical risks.

Main contributors - Jon Gordon, Vincent Heaney

Content is a product of the Chief Investment Office (CIO).

Original report - Is the Fed the biggest risk to your portfolio?, 6 March 2023.