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Article | 14-minute read

Measure once, cut twice?

July 2022

With central banks on a mission to tame inflation, many are questioning whether the current hawkishness is likely to be maintained or if markets will be sent over a cliff into recession; forcing policy makers to change tact once again.

Our Chief Investment Office explores further.


Our View

In building parlance, the expression measure twice, cut once, references the need to check one’s measurements twice before cutting to avoid costly mistakes. Essentially, plan and prepare carefully before acting.

At the onset of the pandemic in early 2020, as global economies were locked down, policy makers had little time and no previous playbook to reference. Instead, swift, and decisive action was required to avoid mass unemployment and corporate bankruptcies. The ensuing decision to slash policy rates to near-zero and unleash a swathe of fiscal stimulus, the likes of which had never been seen, not only saved financial markets but lit a rocket under them, sending them soaring to new highs.

Seemingly unbeknownst to them, and despite continual warnings from key commentators, policy makers insisted on keeping rates at highly stimulatory levels under the guise of inflation being transitory. Markets subsequently overheated, as the consumer — who had never been in better health (financially at least) — sought to take advantage of cheap credit and the fiscal advantages afforded to them. Rather than proving transitory, inflation became entrenched and now those same policy makers who resisted warnings are vigorously hiking rates to bring it under control. In the near-term, these policy makers face a very real and uncomfortable predicament of potentially needing to jettison rates once more or face the prospect of dragging economies over the recessionary cliff.

The 75-basis point hike by the US Federal Reserve (Fed) in June saw US 10-year rates reach 3.5% and US 10-year break evens retreat to 2.6%, leaving a real-yield of 0.9% and risk assets in freefall. In our view there are at least three possibilities as to why Fed Chairman Powell sought to unwind the calm he had tried to restore only weeks earlier.

  1. The global economy is fading fast and therefore the window for rate increases is closing alongside it. The Fed believes it needs to jack rates up quickly, to provide enough dry powder should it need to stimulate growth once more. 
  2. Powell wanted to scare investors out of large energy position and in the process bring about some reduction in inflationary pressures, which until recently, proved resistant to the Fed’s hawkish overtures.
  3. Inflationary pressures are more broad-based and supply-side driven than many expect. And if unable to control the supply-side (energy costs and food shortages — exacerbated by the Ukraine war), a 75-basis point hammer, followed by another, and possibly more thereafter should at least put a dent in the demand side.

US Real-Yields Turned Positive Once More

Source: Bloomberg, ANZ PB&A CIO as at June 2022.


Currently, whether a recession is imminent or not is somewhat of a moot point. The bigger question remains as to whether a recession will be shallow and short-lived i.e., a technical recession of two quarters of negative GDP growth or something more sinister and long-lasting, the kind investors fret about when the ‘R’ word is mentioned.   

Given the starting point for economies, and strength of corporate and household balance sheets, we are currently leaning towards the former. And this is what is shaping our thinking when positioning portfolios. Should a mild recession transpire, and we enter a period of low growth and low inflation, then bonds will likely be required to rally before equities make a more meaningful resurgence. If it’s the latter, and low growth is accompanied by higher sustained inflation (stagflation) then positioning will depend on whether the Fed prefers recession or sustained inflation — a recession may be the more politically acceptable option at this point. A more nuanced approach will be required here.

In our view, the time to increase duration in portfolios is nearing. The yield on corporate bonds is incredibly strong and real yields are positive. This creates an incredibly difficult environment for equities to rally in a sustained manner, given higher borrowing costs for corporates and the appeal of less risky alternatives for investors. It's therefore likely that repricing of bond markets will need to occur before equities can once again advance higher over the medium-term. However, while the time is approaching, we are not there yet and expect volatility to continue while the Fed keeps market participants guessing. Rather, we have begun making small tactical changes to risk allocations within portfolios. With so much negative news priced into markets, we believe any positive surprises could spark a short rally. In this scenario we may look to sell risk assets into market strength and redeploy into bonds.

The Fed and other central banks might be forgiven for being so far behind the curve initially. However, with markets and economies desperately looking for stability, and the risk of a deep recession in play, one hopes that central banks have accurately measured the impact of the sharp hiking cycle currently underway. If not, it may very soon be a case of measure once, cut twice, with some very costly consequences for all concerned.

What this means for our diversified portfolios

As noted, the case for bonds is getting stronger and we believe the next major shift within portfolios is likely to be an increase in duration at the expense of risk. Timing such moves is incredibly difficult, however, markets have fallen so sharply already this year that another steep fall is only likely to come from a deep recession. Something we see as unlikely in the short-to-medium term. Rather, with markets so depressed, and portfolios positioned so bearishly, any positive news flow or data could spark a very short and sharp rally in equities. We wait for such a move to sell equities into strength.

Our benchmark position to risk assets is retained this month but we have commenced tactical adjustments within risky assets. Unhedged developed market equities have been trimmed back to benchmark with proceeds deployed into emerging market shares and global real estate investment trusts (GREITs) — both are now positioned at a mild overweight. In the case of emerging markets, this has been executed via a discreet investment into unhedged Chinese shares.

Chinese shares have underperformed considerably over an extended period, dragged lower by economic concerns relating to China’s Covid-zero policy, regulatory crackdowns across key sectors and political instability. Valuations have been appealing throughout, and now that regions appear to be reopening on slightly more amenable terms and policy is forecast to be stimulatory — as opposed to contractionary elsewhere — we see a more favorable backdrop for outperformance over H2.

The increase to GREITs is premised on a similar wavering of headwinds and appealing valuations, following sustained underperformance over the course of 2022. Strongly rising bond yields have weighed heavily on this segment of the market. With yields expected to stabilise and incredibly attractive valuations, we see upside potential in the asset class. Furthermore, with inflationary pressures remaining strong, the characteristics of ‘real assets’ should provide some inflation protection to portfolios.


Portfolios are positioned at benchmark to Australian shares. We currently prefer developed market equities — owing to a greater quality bias— and emerging market shares, specifically Chinese shares, which have materially underperformed over the year-to-date and should receive a tailwind from the Chinese economy reopening and divergence in policy measures over H2.

The domestic share market continued it's downward trend in June, underperforming global equity markets for the second successive month, to the tune of 1.9 percent and 4.4 percent in hedged and unhedged terms respectively. The local index enjoyed significant relative outperformance versus global peers over the start of 2022 but has since stumbled.  Over the month, the ASX 20 outperformed the ASX 300 ex-20 by more than 2 per cent, helped by stocks within the Energy, industrials and Consumer Discretionary sectors.

Commodity prices have come under pressure in recent weeks, and we see the opportunity for outperformance from Aussie shares waning in line with this trend. Banks remain attractively priced if a recession can be avoided, however, if a material downturn eventuates then further weakness is likely. With the current headwinds and such a large portion of the index occupied by miners and banks we see better relative opportunities in risk assets elsewhere, namely global developed market shares and emerging market equities. Despite gaining some ground over June, the year-to-date value/growth differential remains extremely wide by historical standards and leaves further opportunity for underperformance relative to global peers.

ASX 20 vs. ASX 300 ex-20 – Q2 Performance

Graph showing ASX 20 vs. ASX 300 ex-20 – Q2 Performance data

Source: Bloomberg, ANZ PB&A CIO as at 30 June 2022

Global equity markets fell sharply in June as extreme moves across equity and bond markets followed the May US CPI release and subsequent 75 basis point rate hike by the US Federal Reserve. Volatility increased as investors debated the ability of central banks to engineer a ‘soft landing’ and the potential size, likelihood, and impact of a recession on markets if they can’t.

We have slightly downgraded developed market shares on a relative basis this month and trimmed exposure within portfolios. In the near-term we see better upside potential in emerging markets shares and GREITs. However, we remain at benchmark based on reasonable valuations, and the so far resilient US consumer which should allow growth to continue in the near-term — albeit at a much slower pace. With investor sentiment so depressed, and bull/bear indicators incredibly negative, even the smallest positive surprise amongst the slew of incoming data could trigger some near-term respite for equities.

Quality stocks with high dividend yields, pricing power and stable margins should perform better in this environment.

Developed Markets – Q2 Regional Performance

Graph showing Developed Markets – Q2 Regional Performance data

Source: Bloomberg, ANZ PB&A CIO as at 30 June 2022

Emerging market equities outperformed developed markets over June, providing some level of diversification to portfolios during the month.

This month we have increased our exposure to emerging market shares, taking the position to a mild overweight.

Emerging market shares have suffered heavy falls over the course of 2022 as China’s zero-Covid policy, the Ukrainian war and a strong US dollar weighed on the index. While valuations have been attractive throughout, those headwinds were too strong to increase positioning. Now that China appears to be reopening and activity levels improving, the entry-point is reasonable enough to increase our holdings. Moreover, while Chinese earnings remain susceptible in the near-term the economy is expected to benefit from easing policy in H2 as stimulus measures, primarily fiscal, are used to restart the spluttering economy. This contrasts with most of the developed world where monetary tightening is only just beginning and fiscal measures are being unwound. The potential easing of regulatory headwinds for key sectors including technology could provide a further boon. Finally, US dollar strength remains strong, but should peter out alongside peak rate expectations.

Emerging Markets – Q2 Regional Performance

Graph showing Emerging Markets – Q2 Regional Performance data

Source: Bloomberg, ANZ PB&A CIO as at 30 June 2022

Listed real assets fell heavily alongside most risk assets over the month of June. Global real estate investment trusts (GREITs) underperformed listed infrastructure in the process, continuing a trend which has seen us re-evaluate our positioning within portfolios. On a year-to-date basis, GREITs have fallen more than 18% to be the worst performing risk asset in portfolios. Meanwhile, listed infrastructure has not suffered nearly as heavily and remains down only 4% over the same period.

GREITs have been hampered significantly by strongly rising bond yields. With an expectation that yields are unlikely to trend higher again in any meaningful way and given valuations are incredibly attractive, we see upside potential in the asset class. Furthermore, with inflationary pressures remaining strong, the characteristics of ‘real assets’ should provide some inflation protection to portfolios.

Conversely, while listed infrastructure remains attractive given it's ability to act as an inflation hedge, it hasn’t fallen by the same level as GREITs and therefore the entry point is not as enticing.

In addition to a hedge against inflation, listed real assets provide valuable income and diversification to portfolios. As such, we have increased GREITs to a mild overweight in portfolios and remain mildly underweight infrastructure.


Graph showing global infrastructure vs. global equities data

Source: Bloomberg, ANZ PB&A CIO as at 30 June 2022

Global high yield is at an interesting juncture. Like most risk assets, should a deep recession be avoided the asset class looks ripe for investment. However, should recession eventuate then headwinds will be significant. We hold onto our very mild dislike for duration at this time and given this we remain at benchmark to high yield, favouring GREITs and emerging market shares within risk assets.

High yield typically performs well in an environment of both moderate growth and inflation. Strong economic growth and low inflation followed the depths of the pandemic, and we are now entering a period of weakening growth and possibly higher sustained inflation. Despite very attractive valuations, high yield spreads appear tactically vulnerable to weaker fundamentals including slowing growth, fading central bank liquidity and a recession tail risk which would provide a possible backdrop for higher default rates. Moreover, recent moves in bond markets have seen the yield on government bonds (which are accompanied by a lower risk profile) increase to the point that the risk premia is not enticing enough to increase our position at this time.

Bloomberg Global High Yield – Option Adjusted Spread to Treasury

Graph of global high yield data

Source: Bloomberg, ANZ PB&A CIO as at 30 June 2022

Bond yields rose sharply in June, the Aussie 10-year government yield surpassing 4% mid-month and trading at it's highest level in almost a decade before retracing toward month-end. The domestic economy continues to produce strong data and, with unemployment near 50-year lows and wage growth finally showing up, expectations are for a further 50bps hike in July. Markets repriced the end-of-year cash rate significantly throughout June, rising more than 50bps to more than 3.6% mid-month, before lowering to a more reasonable 3.2% by month-end. Despite this it still seems too rich for our liking

We retain our mild overweight to Aussie rates this month and mild dislike to duration overall. The domestic market has a lower duration profile than the global bond market — where we remain mildly underweight — and combining the two positions provides a very minor underweight to duration as a result. Given the time for increasing bonds may be nearing we are reluctant to cut this position at this time.


Graph of 10y Australia bond yield percentage

Source: Bloomberg, ANZ PB&A CIO as at 30 June 2022

A single-minded Fed, intent on taming inflation, sent global yields higher again in June, the 10yr US Treasury yield closing in on 3.5% mid-month, prior to declining almost 40bps before the end of the month. This saw the US 10-year breakeven retreat to almost 2.5%, leaving a peak real-yield of 0.90% — subsequently sending risk assets tumbling.

Yields are incredibly attractive; however, we believe it is still too early to increase duration in portfolios just yet as inflationary pressures are broadening. Yields are unlikely to push much higher from here and while equities remain super depressed the possibility of very near-term outperformance is skewed towards shares — given even a minor positive surprise could provide a boon for equities. In the short-to-medium term, we believe the likelihood of an increase to our bond allocation is becoming stronger. Peak hawkishness has seemingly been reached and some repricing will be required before equities make a more sustained rally. While moving closer to such an inflection point, we aren’t there yet and maintain our very mild dislike for duration and global bonds for another month.


graph of 10y Australia vs. US treasury 10y data in percentage

Source: Bloomberg, ANZ PB&A CIO as at 30 June 2022

Souring risk appetite has continued to weigh on the AUD in recent weeks, as focus has turned to the global growth outlook. In this environment, USD strength has hampered upward moves by the AUD, as hawkish rhetoric from the Fed fuels expectations of a steep tightening cycle. Peak USD strength may be dependent on a peak in rate expectations, which continues to oscillate as data is released.

Moreover, weakening commodity prices have starved the AUD of a historical tailwind as iron ore and copper prices lay beholden to China’s zero-COVID policy. The moving feast that is China means that commodity rallies will likely prove to be unreliable support for the AUD.

Onshore, the economic narrative remains positive. Unemployment is improving further, touching levels not seen in almost 50 years and wage growth finally appears to be heading north. While this has seen the RBA adopt a more hawkish narrative, market pricing remains too aggressive for our liking and therefore this tightening cycle may mean short-lived support for the AUD. Rather, it’s likely that the AUD will move in accordance with global risk appetite. We have marginally downgraded our year-end forecasts accordingly.

Within portfolios we remain mildly underweight the AUD, continuing to prefer developed market foreign currency exposure. As noted above, should markets continue to adopt a risk-off stance, the position should provide some capital protection to portfolios.

Key commodities for AUD weaken

graphical view of key commodities for AUD weakens

Source: Bloomberg, RBA, ANZ Research

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