April was a positive month for equity markets worldwide, with the S&P/ASX 200 returning 1.7% for the month and the MSCI All Country World ex-Australia returning 2.6%.
Inflation
Through April we finally saw inflation decline, with the Australian Bureau of Statistics (ABS) reporting a quarterly increase in the consumer price index (CPI) at 1.4%. This was lower than the increase recorded in December, which was 1.9%. Annual inflation fell to 7.0% in March, which was down from 7.8% in December. Although there is still some way to go before inflation retreats to the Reserve Bank of Australia’s (RBA) target of 2% inflation, this gave markets optimism that we are now on the other side of the peak, with pressure from interest rates likely to ease.
RBA Cash Rate
You can see on the chart below that over the last 3 years, since inflation concerns entered the discussion, the market successfully predicted the RBA would need to raise earlier than it had expected. After the March rate hike to 3.6%, the 3-year yield started falling.
US Bond Market
We are seeing a similar phenomenon in the United States. The bond market started pricing the 3-year US government bond yield for rate hikes in July 2021 and yet the Federal Funds Rate (the US equivalent of our cash rate) was not raised by the Federal Reserve until March 2022 when it was clear that inflation needed to be dealt with at the economic level.
The Fed raised rates again in May to 5.25%, and yet the bond market is pricing the 3-year at 3.64%, suggesting an expectation that official rates are due to fall.
There is a chance that the decline in yield relates to a flight to safety from regional American banks. But futures are pointing to the same outcome.
Notably, there is a delay between what the market prices in and when the central bank comes to its conclusion. Consequently we may still be waiting some time. We cannot predict when the RBA or the Fed responds this time, but we believe that the rate peak is near and it is only a matter of time until the cash rate either plateaus or begins falling. Either way, this will be positive for equity markets in the medium to long term and as discussed previously we have started positioning the portfolios to benefit from this in measured and considered ways.
Commodities Update
Commodities were weak through the month with copper falling 5.6% from its intra-month high, Brent Crude oil falling 19% from its high (albeit after rising a similar amount in March), and iron ore falling 18%. In regards to iron ore, this was in response to Chinese Mills being told to cut steel production, which uses iron as a key input. The Australian Financial Review also cited a few reasons why it is likely to remain weak this year including the end of 2023 inventory restocking, China steel production being capped and a recovery in supply from major miners. We tend to agree and have therefore decreased our exposure to iron ore in the portfolios.
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