MEDIA RELEASE: Interest rate uncertainty is driving a high level of market volatility and sector returns dispersion as investors grapple with how fast and for how long central banks will raise rates, according to SG Hiscock & Company portfolio manager, Hamish Tadgell.

At start of the year, there was a growing mood that central banks would slow the pace of rate rises to assess the impact so far, leading to a rally by many longer-duration, higher growth stocks.

“However, better economic data and China’s reopening, along with upgrades to global growth and reduced concerns around a US recession, saw rate expectations move higher again from February, and many of these stocks have given back their gains,” he said.

Mr Tadgell said the collapse of Silicon Valley, Silvergate and Signature Banks have only added to market volatility and uncertainty around the path of interest rate tightening.

“It is not surprising given the aggressive and co-ordinated tightening we have seen over the last 18 months that we are starting to see some things break.

“The UK liability driven investment market crisis last September, collapse of FTX in November, and now US regional bank collapses all seem to have been largely self-contained events and not systematic.

“At their heart, they appear to reflect more a failure of risk management and mismatching off assets and liabilities, coupled with perverse incentives and in the worst case, fraud,” he said.

Mr Tadgell said the rapid moves in rates and repricing of assets will likely trigger more business failures.

“Events such as those in the US can quickly undermine confidence and be very dangerous. Swift regulatory action and oversight like we have seen is critical in managing potential contagion risk and confidence. It is also an important alarm to the risks and vulnerabilities when financial conditions and credit spreads change as quickly as they have.

“The risk something more serious breaks in raising rates versus the risk of not getting on top of inflation is an increasing dilemma for central banks,” he said.

In Australia, the added challenge for the Reserve Bank of Australia is underlying inflation is proving higher than global peers on the back of better economic momentum. There are signs that supply chains and commodity prices have eased and goods inflation is receding, but services and rental inflation is proving sticky, driven by tight labour market conditions and the large job-worker gap.

“There is an expectation labour market conditions will start to cool with the recovery in migration and population growth. Coupled with the lagged effect of rate rises to date, economic growth should contract through 2023 and into 2024 and unemployment increase, and this should give the RBA more opportunity to pause.

“It also needs to be remembered the Australian economy is more economically-sensitive to rising rates given the nature of the housing market and link between higher official cash and mortgage rates. Australian households are starting from a position of relative strength, but it is expected as higher rates eat into savings consumption growth will slow,” he said.

While the outlook for the Australian economy looks more challenging, importantly there are areas of ongoing support largely linked to commodities, which should continue to drive national income and positive terms of trade, and population and immigration growth.

“The China reopening is an important positive and reduces the risk of a recession. Chinese pent up household savings after being locked down for two-years, combined with timing of the academic year, should be positive for both tourism and education and companies like Corporate Travel Management and IDP Education. Easing trade tensions could also provide an additional boost for the agriculture and the wine sector, such as Treasury Wines Estates.

“While China’s reopening has seen strong outperformance in metals and mining stocks, and particularly the large cap iron ore producers, there is yet to be any clear evidence that the government is planning to stimulate growth in the housing and infrastructure sectors.

“We continue to see a better margin of safety and risk reward in the energy stocks which have lagged, but should benefit from the recovery in Chinese mobility, and both domestic and international air travel as well as ongoing benefits from the structural energy transformation,” he said.