Sentiment improves as bank risks ease

• There was a reprieve rally in global markets last week on the back of receding fears over the banking sector and strong Chinese data for March.
  
  
• First, while not entirely dissipating, liquidity pressures for US banks did stabilise. Net outstanding borrowings from the Federal Reserve (Fed) lending facility programmes declined by USD 11 billion compared to the previous week. This suggests deposit outflows from smaller banks are not picking up. As a result, after a volatile couple of weeks, global equity indices rose across the board. Credit Default Swap spreads (which reflect the cost of protection against credit events like bankruptcies) for the largest banks have also decreased. Meanwhile, demand has eased for safe-haven currencies such as the US dollar and Japanese yen.
  
  
• Second, in China, non-manufacturing activity grew at its fastest rate in more than a decade in March, suggesting that domestic demand is rebounding strongly and sending shares higher across the Asia-Pacific region.
  
  
• Third, while headline inflation has fallen in the eurozone, underlying price pressures remain strong (core inflation, which excludes volatile components such as food and energy, reached an all-time high). The data suggests that the European Central Bank (ECB) will raise interest rates at the May meeting. However, we believe it will scale back from the previous 50 bps rise to 25 bps to balance downside risks from the bank stresses. The inflation print (as well as improving risk sentiment) pushed sovereign bond yields higher, as investors firmed up their expectations on the next ECB decision.
  
  
• OPEC+ surprisingly announcing significant production cuts sent oil prices higher and fuelled fears that inflation could be stickier than previously thought.
  
  
• This week, as banking fears have receded, economic data such as the US jobs report and ISM surveys of purchasing managers will take centre stage. Both are expected to soften, supporting our view that the Fed will increase interest rates by 25 bps increase in May before pausing.

Here’s how we are positioned in our flagship portfolios:

• Despite the volatility in March as concerns grew in the market over the health of the banking system, portfolios showed positive returns across risk profiles over the first quarter. The key performance drivers were:

1. Our focus on quality within fixed income, with higher-than-normal exposure in government bonds, and reduced exposure to high yield and emerging market debt;
2. Our selection of equity investments, as several technology stocks, for instance, have performed strongly and a lower exposure to the struggling banking sector;
3. Our strategic gold position, which proved to be a good diversifier amid rising uncertainty.

• Markets remain volatile, with bouts of pessimism and financial instability alternating with optimism. We think this volatility implies a need for more portfolio diversification, which is why we are adding a global value fund. It brings exposure to some ‘traditional’ economic sectors we previously had limited exposure to.
  
  
• Central banks need to balance financial risks vs inflation risks. While financial volatility remains elevated, inflation could be stickier than expected – given the recent oil price spike following OPEC+ supply cut. This is why we are adding inflation-linked bonds (US TIPS).
  
  
• At this stage of the cycle, we maintain our overall positioning but want to highlight two key points:

1. We believe the ongoing reopening of China will continue to accelerate, underscoring our overweight positioning in Asia-Pacific equities.
2. Similarly, as we approach the peak in interest rates, we remain confident in holding high quality government bonds as we believe monetary policy tightening will continue to feed through the economy with a lag, which will weigh on growth.

Past performance is not a reliable indicator of future returns.