November was a good month for markets, as equity markets in the US and abroad rose. Foreign markets rose more than US markets, as the US dollar reversed its trend of strength and weakened. Emerging markets were the leader, as China’s priorities began to shift away from “Zero-Covid” policies to the health of the Chinese economy.
The environment in fixed income markets improved, as longer-term rates began to ease, a trend that has continued into December. Government and investment-grade bonds benefited more than riskier borrowers. High yield bonds lagged on a relative basis but have held up better than most other fixed income assets on the year, an outcome we attribute to their shorter term maturities, less duration in financial-speak, and higher current income. This has been a little unexpected in the face of steadily higher borrowing costs and a greater risk of a default cycle developing.
Much of the decline in longer-term rates and reversal of dollar strength can be attributed to decelerating inflation, which could result in a less hawkish Fed in 2023. Whether that happens or not remains to be seen, but the real-time data seems to be supportive of that view and the market is beginning to incorporate decelerating inflation into asset prices.
There is a risk the Fed does too much for too long, particularly if the data no longer supports their actions. We think that the Fed thinks it harmed its reputation by insisting inflation was “transitory” in 2021 and has sought to re-establish their credibility as inflation fighters with hawkish behavior and rhetoric. In our view, that goal has been accomplished. There is also a risk they squander their newly re-gained credibility by putting themselves, and the economy, in a situation where they need to backtrack quickly. We also think they know that and expect them to be pragmatic rather than dogmatic.
