QIC: Don't bet on rate cuts

Hopes that the US Federal Reserve Fed would start cutting rates later this year were dashed by the hotter-than-expected jobs figures in the US.

Before these numbers were released last Friday, the market had priced in roughly one more rate hike before the Fed started aggressively cutting rates later this year based on a slide into a recession.

On the release of the strong jobs data, Fed chair Jerome Powell confirmed that the central bank will likely deliver a "couple" more interest-rate increases before ending its aggressive drive to fight high inflation.

Importantly, Allison Hill, QIC's state chief investment officer, didn't have to wait for the January numbers that flagged a white-hot labour market.

She had already banked on at least two more rate hikes taking the terminal rate to 5.25 per cent.

Hill believes the Fed will hit likely to pause for a time.

In her view,  it's likely the Fed will want to keep some flexibility in its tool kit, and if the economy is reasonably robust, there is no need for rate cuts in the near term.

"It will only do this in the case of a much deeper recession where it needs to stimulate growth," she says.

Inflation might have peaked in the US, but the issue for her is where rates will ultimately settle.

Hill argues that due to base effects, inflation will, and has begun to slow down.

"The question remains however whether inflation slows enough to get it to the Fed's target band, or close enough that the Fed can pause rate hikes to protect economic growth in the US," she adds.

QIC's central case is that likely to be a small, shallow recession in the US before economic growth recovers again.

Hill says there are diverse opinions on where rates will go even though we have more clarity about inflation.

For Hill, the Fed is looking not looking only at inflation data prints, which is just one data point with many other data points such as employment and wages, to determine whether it has inflation under control.

"The Fed wants to be confident that it has squashed the inflation genie rather than having to patch things up with 1970s-type policies later on," she warns.

On the local front, Hill has penciled in another quarter-percentage point rise in March following Tuesday's 25-basis point increase - the ninth straight rate rise.

"This would take rates to 3.6 per cent, where I believe they will stick for a while," she concludes.

"I think the Australian economy is pretty robust. I don't think we'll go into recession, and on that basis, there's no reason for the RBA to cut. It's better off just making sure that it can keep the more normalised rates to allow for future flexibility."

More price volatility

To Hill, that doesn't mean the picture for asset prices is clear - there are still degrees of uncertainty.Like many of her peers, Hill expects to see some volatility in equities and bonds for at least six to 12 months.

While corporate earnings look reasonably strong through this earnings season, she notes that sales outlook is softening in Silicon Valley, where many tech giants have laid off in a bid to protect profit margins.

"They foreshadow a weaker economic environment which will lead to margin pressure and slower earnings growth, and the staff cuts are seeking to protect high margins expected by shareholders."

Hill notes that while the market has made some adjustments slowing earnings growth, it has failed to make the adjustment one would expect ahead of a recession.

"It is possible that we could see some softness in equity equities over the coming six to 12 months in line with a slowing economy that the market has not fully priced in.

As for bonds, she says there is more of a consensus as with inflation peaking, it can be more confident about the Fed finding a point where it can pause tightening. This doesn't mean the end to volatility however with many differing perspectives on Fed policy.

Private debt still winning strategy

Multi-asset private debt continues to be a focus for QIC and Hill plans to increase the eight per cent allocated to this asset class.

She doesn't see creditworthiness challenges, as while earnings may slow, corporates, in general are not overly indebted.

Hill says there is a broad universe of credit opportunities domestically and internationally for QIC to build out exposures.

We are continuing to build into that space because I think you can get comparatively reasonably strong risk-adjusted returns in the private credit space." For me, that adds a degree of lower volatility return stream which I think is important to have as a core part of our portfolio, and aids to diversification alongside our sovereign bond and equities exposures.

Elsewhere, Hill is looking to maintain QIC's portfolio of property and infrastructure assets but tilting away from equities as earnings might slow at the margin. Longer term, she is positive on equities. "Certainly, we think it's important to not only be thinking about the beta exposure, but also the alpha that can be a strong addition to returns."

She says there are greater opportunities for opportunistic investing than before, especially for dynamic tilting. With rates anchored at around zero for many years tilting was difficult. "Now we have a much more active opportunity set with moving fixed interest rates, moving currency rates, and also potentially more divergence across the globe.

The US, Europe, Australia and China are more complicated than before.

"There are more opportunities for dynamic shifting, and the diversity will offer a wider opportunity set.

Earlier, the Fed provided a backstop to equity markets, but that discouraged thinking about the breadth of opportunities.

For a start, she has taken a tilt towards Chinese equities based on the reopening of the economy post covid and noted that Beijing is being stimulatory rather than raising rates like the rest of the world.

Hill says the reopening of China is tremendously important because of the likely rebound in the economy as we saw in other major economies opened post the pandemic.

She can see a "J" curve or hockey stick as the population starts travelling, consuming and resuming a more normalized life after a very long lockdown.