The inflation battle is not over

• The message from central bankers at last week’s European Central Bank (ECB) Forum was that the overall level of inflation is still uncomfortably high. ECB President Christine Lagarde said that while “significant progress” had been made, policymakers “cannot declare victory yet”. The market reaction was mixed as the price of government bonds in the US and the Eurozone fell (and, therefore, the yield of these bonds rose), while developed market equities rose across the board.
  
  
• Despite high inflation, we continue to expect that central banks are close to their peak in interest rates given the economic slowdown shown in the purchasing managers’ indices. However, the peak in interest rates may be slightly higher than initially expected, with prospects of an additional increases rising mostly in the UK but, to a lesser extent, also in the US and the Eurozone.
  
  
• That said, inflationary pressures are easing in the US and the Eurozone. Last week, the inflation rate for the Eurozone fell from 6.1% to 5.5% in June. Most notably the inflation figure for Spain came below the ECB’s 2% target (1.6% in June).
  
  
• Elsewhere, the recovery in China disappointed again with services activity now expanding at a slower rate as pent-up demand following the post-Covid reopening eases. Slightly more encouragingly, manufacturing activity, as measured by the purchasing managers’ index, increased from 48.8 in May to 49 May in June, although a reading under 50 still means that activity is still contracting. This suggests more interest rate cuts and extra fiscal stimulus could be on the horizon to boost growth.
  
  
• This week, apart from more purchasing managers’ data out of China and the US, the market will likely focus on the minutes of the latest US Federal Reserve (Fed) monetary policy decision for any clue on the near-term interest rate path. The US jobs report this Friday may be important as well: the market is looking for an unchanged unemployment rate at low levels, highlighting a tight labour market; but for signs of slowing employment and wage growth, possibly suggesting some initial signs of weakness.

Here’s what happened in our flagship portfolios during the first half of the year:

• Following a challenging 2022, the first half of 2023 has yielded positive results. Performance benefited from maintaining the bulk of the strategic positions held in 2022, particularly US equities, and our in-house stock selection. We have taken profits in strongly performing US equities and allocated these towards low volatility European equities for their defensive characteristics.
  
  
• While some 2022 positions contributed to performance, others, which were added in late 2022 to diversify portfolios, have not performed as well. For example, our US low volatility and dividend exposures. However, we maintain our conviction in these positions as these can provide stability in portfolios should there be spikes in volatility in the coming months.
  
  
• As we head into the second half of 2023, our portfolios hold a higher-than-normal exposure to high-quality government bonds, with fewer equities and riskier bonds than normal. This is because of the uncertainty around the macroeconomic outlook and the potential market headwinds mentioned above.

Past performance is not a reliable indicator of future returns