Macro Matters March 2022

(Source: Merlea Macro Matters)


The developing situation with regards to the extensive Russian military mobilization surrounding Ukraine was initially ignored by the market (like how covid was also initially ignored in early 2020). It is uncertain whether war will break out between the two countries, but some analysts say Russia could move in on Ukraine to claim a quick, decisive victory and increase its bargaining power in future talks about NATO’s expansion and spheres of influence.

Western nations have thrown their support behind Ukraine and there has also been much talk of sanctions aimed at punishing Moscow. If Putin does roll his military into Ukraine the US and European allies have promised to hit Russia financially like never before. Leaders have given few details, arguing it is best to keep Putin guessing.

Geopolitical risk is never easy for financial markets to price. In general, it affects asset prices through at least two channels:

sentiment in the markets and in the real economy, and (often but not always) energy prices. Energy prices can present a dilemma for central banks because they lower growth and raise inflation at the same time. If energy prices soar persistently this year, both the Fed and the ECB are likely to react very differently.

The Fed is very much focused on the risk of inflation expectations breaking out on the upside, so it could well turn more hawkish, at least initially, due to a rise in energy prices. This is because ensuring well-anchored inflation expectations is a necessary condition of the Fed to be able to pursue other goals, such as full employment. Of course, the accelerated pace of tightening will trigger a further tightening of financial conditions and act as an additional damper on growth.

At some point, when the Fed feels inflation expectations have been protected sufficiently, it may turn dovish to cushion the economic downturn. By contrast, the ECB might be willing to look through an energy price spike. Because wage inflation is well below their pre -Covid trend, and because inflation expectations remain at levels consistent with the inflation target, the ECB is likely to consider the risk of second-round effects very limited. The oil price spike will be seen primarily as a downside growth risk because it reduces real household disposable income and real business profits.


With economies recovering from the pandemic and major central banks planning to tighten policy to control inflationary pressures that are proving to be more persistent than expected, major sovereign bond yields are forecast to rise. The world’s central bankers seem to have concluded that the coronavirus pandemic is more likely to drive inflation higher than to push economic growth lower. In response to stubbornly elevated inflation, central banks around the world are pivoting toward tighter policy. The pivot isn’t uniform, because policy stances and the severity of the inflation shock differ among countries. For instance, although the US Federal Reserve has accelerated its tapering of QE and is now headed toward rate hikes as soon as March, some smaller developed-market central banks have increased rates already, and many emerging-market (EM) central banks have tightened significantly. Japan is the exception to the tightening trend, thanks to its low inflation; in fact, the country recently announced significant fiscal stimulus just as other countries tap the brakes.

As the year progresses, tighter policy worldwide is likely to slow global growth. These conditions—climbing short-term rates and slowing-but-still-strong growth—are a recipe for flattening yield curves. And flatter yield curves signal caution when it comes to taking risk

Hotter-than-expected inflation is the gift that keeps on taking — and wage inflation has chipped in more than its fair share. Last week’s US CPI data showed levels not seen since the 1980s, which came on the heels of January’s jobs report and a jump in average hourly earnings. We see the nearly 6% year-over-year wage increase as a wildcard in the overall inflation picture. And the Fed is eyeing it like — well, like a hawk. The massive market shift and St. Louis Fed President James Bullard’s embrace of a full percentage point’s worth of rate hikes over the next four months suggests an internal Fed debate over how fast and high to raise interest rates will only intensify ahead of the next rate-decision meeting on March 15-16.

The chief risk is the Fed will err on the side of ratcheting up its already aggressive tightening plans, potentially sinking the recovery. Expectations that the U.S. Federal Reserve may increase rates more aggressively than anticipated to counter rising inflation have pushed up yields while flattening the U.S. Treasury yield curve. That matters as bond yields impact global asset prices as well as consumer loans and mortgages.

The shape of the U.S. Treasury yield curve can also help predict how the economy will fare. Yields on 10-year notes hit 2% after higher-than-anticipated inflation data. Federal funds rate futures showed an increased chance of a half percentage-point tightening at next month’s meeting after the data, while strategists said the data increased the chances of swifter moves to reduce the Fed’s balance sheet.

Australia: Bonds extended their losses as financial markets ramped up the pressure on the Reserve Bank of Australia to raise the cash rate as soon as May, in response to persistent inflationary pressures challenging its dovish stance. RBA governor Philip Lowe acknowledged last week that monetary tightening in 2022 was a “plausible scenario”, though the bank’s forecasts imply 2023 as more likely. The RBA has argued for patience until inflation and wage growth are sustainably higher.

Listed Property

Macroeconomic drivers remain strong for REITs with GDP growth of above 4% coupled with sound corporate balance sheets (average gearing for REITs at 27%) and household savings at an all-time high of 20%.  However, three obstacles challenge the outlook over the near term, including ongoing high levels of COVID-19 infections, production and supply chain bottlenecks and an elevated inflation rate.

The onset of the new Omicron variant will most likely place some caution on consumer sentiment and employees going back to the office. Whilst CPI remains high at 2.8%, driven by rising food and energy prices, sky-high shipping costs and persistent supply shortages will keep inflation around the top end of the RBA’s target band. The question is – will the RBA raise rates to curb inflation and, if so, how will REITs perform in this environment.

Listed A-REITs staged a strong comeback in 2021, with the S&P/ASX 200 A-REIT Accumulation Index delivering a total return of 26.1% for the year. A-REITs also outperformed the broader S&P/ASX 200 Accumulation Index, which was up 17.2%.

 Firstly, we have adopted a conservatively high risk-free rate in our valuation of REITs providing us with a buffer in the event of further rate rises. Secondly, it has been shown that during periods of moderate inflation, REITs tend to outperform the broader market. This is because rents are not as sticky as other prices. Long-term leases typically have inflation protection built-in, and shorter-term leases are based on current price levels. To put things into perspective, interest rates are looking to rise but from a very low base. In this environment, we continue to see support for the REIT sector delivering a sustainable forecast income yield of 4%.

The key themes to impact stocks in 2022 will include a focus on the strength of earnings from property portfolios. We also anticipate a renewed focus on interest rates during the 2022, with concerns that higher rates, or the expectation of higher rates, will make operating conditions more challenging, and consequently impact property valuations. During such periods it is usually the better managers with low gearing who can perform. The impact of COVID-19 on the listed market can be characterised as being volatile in 2020, following by a strong recovery in 2021. Our expectations are that over the next 12 months there will be a renewed focus on growth. Managers with portfolios that can demonstrate sustainable growth are likely to be rewarded well.

We continue to favour REITs with positive free cash flow and a strong balance sheet coupled with active managers who can add value through development and capital management. 2022 will be a year of continued structural shifts, favouring the growth of the alternative sectors and increased M&A activities as REITs look to grow and diversify earnings.

Australian Equities

Australia’s challenges are arguably matched by just as many opportunities – opportunities to leverage growing corporate appetite to invest in emissions reduction, get as many Australians as possible into jobs and draw on rapid advances in technology to lift productivity. But long-term success and prosperity on par with previous decades will only be achievable if Australia begins to make concerted policy choices to tackle the looming challenges and structural weaknesses of our economy.

The policy choices in the last two years have focused on significant interventions to support demand in the economy. Now Australia must delicately unwind record levels of stimulus, while turning to supply-side reforms that have been largely missing in action over the last decade. The need for concerted policy choices may not dominate the national conversation in the lead up to and during the next Federal election. But they will confront whichever party forms government and future governments this decade.

Minutes of the RBA’s February meeting revealed the Board is yet to be convinced that accelerating inflation will be sustained. Interestingly, the RBA wants to wage growth respond first before moving to adjust interest rates up.

Investors and economists now expect the RBA to start lifting the record low 0.1% cash rate in June, given how inflationary pressures are building across the globe. Markets are fully priced for the 0.1% cash rate moving to 1% by the end of 2022, and one further 25 basis point rate hike early next year that would take the cash rate to 1.25%. Australia’s economy did hit a speed bump in January, as the rapid spread of the Omicron variant impacted, but spending has recovered with cases levelling off, and since have declined rapidly. We are seeing more people returning to the CBD, and businesses are trading back to normal, in a sign the economy is recovering well.

The labour market remains tight however, with unemployment at a 13-year low of 4.2% and job vacancies at record highs. Wage growth has picked up somewhat to 2.2% but still running at less than half the pace of the US (4.7%) or the UK (4.3%). Wage growth is coming and likely sooner than the RBA expects. The RBA is targeting 3% wage growth or more before tightening rates. In a nutshell, economic recovery is expected to continue in the coming year, with labour market developing resilience along the way. Additionally, a recovery in wages could further bring out a radical change in policy action. If wages growth exceeds inflation growth, then it is highly likely that contractionary policy measures would be adopted.

On the earnings front, CEO’s are showing confidence in the outlook for the Australian economy, despite battling rising costs and supply chain disruptions. From the results we have seen to date by Aussie companies this reporting season, that many have been able to pass on these costs and have therefore protected margins and rewarded shareholders with higher dividends. However, for value, cyclicals, commodities and inflationary beneficiaries such as the banks, this provides a strong tailwind and we should see further outperformance in those sectors in the months ahead

Global markets

While geopolitical tensions between Russia and Ukraine and earnings season added to the volatility, there’s no doubt about the main culprit. The Federal Reserve has sketched out its plans to tighten monetary policy and curb inflation, but market participants worry the Fed won’t be able to pull that off without damaging the economy. Together with excess savings, pent-up demand, and loose monetary and fiscal policies, those bottlenecks fuelled inflation in 2021. Many of the central bankers who insisted that the inflationary surge was transitory have now conceded that it will persist.

With varying degrees of urgency, they are planning to phase out unconventional monetary policies such as quantitative easing, so that they can start to normalise interest rates. Central banks’ resolve will be tested if policy rate hikes lead to shocks in the bond, credit, and stock markets. With such a massive build-up of private and public debt, markets may not be able to digest higher borrowing costs. We’ve been in a low-interest rate environment and that’s changing. With higher interest rates comes volatility and some pressure on valuation levels.


Soaring inflation has markets betting on a hefty half-point increase in March. Tightening at central banks remains the major headwind for stock markets right now, particularly for those growth-focused tech names. They have been hurt by inflation eroding the future value of their earnings, which has made up such a large part of their value up to now. With the Fed promising what it calls a “nimble” approach to policy after so many pandemic-era surprises, the ultimate decision may rest on the details of the final consumer inflation report, due on March 10, that the central bank will receive ahead of its meeting on the 15th and 16th of the month.

Fed policymakers are poised to raise interest rates at their March meeting and then continue raising them, to slow the economy. They fear that a labour shortage is pushing up wages, which in turn are pushing up prices – and that this wage-price spiral could get out of control. At this stage of an economic recovery, it is not that unusual for the U.S. Federal Reserve to begin shifting policy and reducing liquidity. Tightening financial conditions weigh on equities, especially the more speculative stocks. However, the fourth quarter earnings reports for corporate America held good news overall. Clearly the earnings misses get the headlines, nevertheless, consensus earnings estimates for the S&P 500 for 2021, 2022 and 2023 are higher today than they were at the end of 2021. Overall, corporate America is healthier than Wall Street has expected. Throw in the resumption of strong company stock buybacks, and there is your good news for stocks. We remain committed to a value bias in the U.S. for two reasons. The first is that in recessions, value stocks have tended to get very cheap. After recessions, they tend to trade back to a normalized level. They are not at that level yet. The second is that we think the economy could be moving into a period of permanent higher inflation and if it does, inflation-sensitive stocks, which reside in the value bucket, could outperform for an extended period.


Geopolitical scares typically produce very short-lived market disruptions, with commodities and risk assets quick to recover. The standoff between Russia and Ukraine could be different. If Russia goes big, it could quickly subdue Kyiv, the nation’s capital, oust the democratically elected government and return the country to de facto Russian rule. Ukraine is a former Soviet republic that has been independent since the USSR dissolved in 1991, and is increasingly aligned with the West. Putin wants to turn back the clock and restore some of the old USSR’s territorial and political dominance, and Ukraine is the main target.

If Russia invades, it could turn out to be a strategic mistake that mires Russia in years of guerrilla warfare and economic isolation. And an invasion could take many forms. The problem for markets is guessing which of many levers Putin will pull. A full invasion would convulse energy and commodity markets and probably trigger a sharp stock selloff, which markets are beginning to price in. If Russia takes over most or all of Ukraine, Europe and the United States will probably impose sanctions that restrict or completely block Russian exports of key commodities including aluminium, nickel, palladium, titanium, platinum, and certain grains.

These are important supply-chain products for U.S. and European producers and losing an important source of world supply will push prices up. This would worsen inflation that is already at 40-year-highs in the United States and Europe. Oil and natural gas markets will quake as well because Russia is a top producer of each and Europe’s No.1 source of natural gas. But a shutdown of Russian energy exports is unlikely. Europe is too dependent on Russian energy to boycott it or include oil and gas on a sanctions list. Russia needs the revenue from energy sales to sustain an otherwise stagnant economy, especially if it’s facing new sanctions while financing a major military operation. Many companies would probably put big investments on hold while waiting to gauge the outcome of the biggest military campaign in Europe since World War II. The stock market reaction to an incursion or invasion of Ukraine may echo those of the past, with little measurable impact for diversified investors. Previous incidents involving Russia had little impact on the markets. For example, Russia’s invasion and subsequent annexation of Crimea from Ukraine in 2014 saw the S&P 500 and other developed- and emerging-market indices around the world dip less than 2% on the day it occurred and rebound at least partially during the following five days.

After a mid-2021 growth spurt, eurozone growth has slowed abruptly in late 2021 and early 2022 in response to record-high energy costs, ongoing supply chain disruptions, and a widespread increase in COVID-19 cases. As these headwinds ease, growth should strengthen in the second quarter. The service-oriented economies in southern Europe should benefit from a rebound in tourism and travel-related activities in the third quarter. After a 6.4% decline in 2020 and an estimated 5.2% recovery in 2021, eurozone real GDP is projected to increase 3.7% in 2022 and 2.3% in 2023.

United Kingdom

UK inflation reached a 30-year high in January and the labour market tightened further, contributing to increased expectations for the Bank of England to announce a third consecutive interest rate increase in March. Consumer prices rose 5.5% from year-ago levels in January—the highest level since March 1992—and up from 5.4% in December.

Meanwhile, the number of workers on payroll increased by 108,000 to a record of 29.5 million in January. The unemployment rate decreased to 4.1% in the final three months of last year. Labour shortages across all sectors continued to squeeze the market, with the number of open positions rising to a record level of almost 1.3 million in the three months to January. Average weekly wages, including bonuses, grew 4.3% in the final quarter of 2021.


Japan’s economic growth was largely dragged down by repeated COVID-19 outbreaks last year, recording negative growth in the first and third quarter. It implemented states of emergency lasting more than 200 days in total.

According to a survey released by the Ministry of Internal Affairs and Communications, the recovery of Japanese household consumption was weak in 2021. Although the average monthly expenditure of households with more than two people reversed the sharp decline in the previous year, the real increase excluding the element of prices stood at only 0.7 percent, below the pre-pandemic level. At the same time, the average savings rate of working households has been climbing for two consecutive years, reflecting residents’ weak desire for consumption. Against a backdrop of sluggish recovery in private consumption, private and public investment, overseas demand has propelled Japan’s economic recovery.

Thanks to the recovery of other major economies, the growth of overseas demand in 2021 was extremely positive to Japan’s exports. Although automobile and other major export sectors have generally seen production cuts or even suspension due to supply-side constraints, Japan enjoyed robust export growth last year, with the annual increase of goods exports reaching 22.1 percent. External demand contributed more to economic growth than domestic demand.

Bank of Japan Governor Haruhiko Kuroda also highlighted escalating tensions in Ukraine as a fresh risk to the central bank’s forecast for a moderate economic recovery. Japan’s recovery, however, continues to lag other advanced economies, forcing the BOJ to keep monetary policy ultra-loose, even as other central banks eye interest rate hike, there’s not much left for the government and the central bank to do in terms of new stimulus measures. Both fiscal and monetary policy have reached a limit.


I have real concerns that Chinese leader Xi Jinping will take lessons from Putin’s high-risk military posturing.  And I believe we should expect that Xi will redouble the Chinese Communist Party’s attempts to assert its control over Taiwan and its longer-term goal for strategic dominance in Asia. China and Russia have become increasingly close since the Russian takeover of Crimea in 2014 and Beijing’s annexation of much of the South China Sea by island building to establish military bases in the same year. Xi is copying Putin’s international playbook. Both leaders take big international risks—consider Russia’s military intervention in Syria and China’s authoritarian crackdown in Hong Kong—both have championed vast and rapid military build-ups, and both threaten the use of military force to press for Western acquiescence.

The Li Keqiang Index is a mix of real economic activity indicators first introduced by Premier Li Keqiang. The Li Keqiang Index is a proxy measure for China’s economic activity.

Since property and its related sectors account for almost one‑third of China’s gross domestic product, some slowdown in the overall economy appears inevitable. However, we believe that the government has the right policy tools to avoid serious systemic risk and a “hard landing.” We believe they will navigate their way around the problems of the property sector with considerable caution. Property has been a major driver for China’s economy over the past two decades. On the other hand, this has contributed to some less desirable side effects, such as a widening wealth gap, a rising cost of living, and the rapid growth in financial leverage. The government is determined to address these structural issues.

This round of financial deleveraging started five to six years ago and continues today. Markets in 2021 underestimated the amount of short‑term volatility Beijing is willing to incur to improve the quality of future economic growth. On the economic news front, China’s Premier Li Keqiang reportedly pledged that Beijing would swiftly roll out a slew of measures to provide stronger support to the economy, parts of which are still suffering from the effects of the coronavirus pandemic. Separately, China’s top finance minister vowed to further cut corporate tax rates, strengthen targeted fiscal spending, and tighten fiscal discipline. Finally, the head of the People’s Bank of China (PBOC) said that the central bank would maintain supportive monetary policy this year.

Emerging markets

It is a misconception that emerging market (EM) stocks always suffer losses when the Federal Reserve hikes interest rates. This perspective developed in the 1990s, when the MSCI Emerging Market Index fell during the one-year periods after the Fed began to hike rates in 1994 and again in 1997. However, history shows that EM stocks posted gains during the first year of the other four rate hike cycles since former Fed Chair Alan Greenspan ushered in a period characterised by more transparent money policy. In fact, the start of rate-hike cycles preceded gains for EM stocks, on average. Many EM central banks have already hiked rates, supporting their currencies. More notably, ample foreign currency reserves, the lack of fixed exchange rates and balanced current accounts across many emerging markets are key differences from the 1990s, lowering the likelihood of a repeat of poor performance during those periods of Fed rate hikes. Emerging markets are looking more convincing; although slow growth, high inflation and tight monetary policy are headwinds.


Commodity markets were supported at the beginning of the year by abating Omicron virus fears, policy stimulus in China, and tensions over Russia and Ukraine. Momentum in crude oil prices was strong. Omicron had less impact than feared on oil demand, mobility was maintained, and virus containment measures are likely to ease. In industrial metals we maintain an overweight view on aluminium. We remain constructive for the medium term but see near-term downside risks as Chinese coal-powered smelters partially return. Seasonal demand around Chinese New Year is also weak.  Precious metals are torn between safe-haven and jewellery demand on the one hand, and a Fed-driven outlook for rising yields and a stronger US dollar on the other.

Agricultural commodities

Prices are expected to ease as weather conditions improve, but they’ll likely remain above long-term price averages. Overall, there are some downside risks across the commodities complex in 2022, however relative to the historical average, prices are likely to trade at elevated levels for another year. With fundamentals tight across key grains and soft commodities, recent setbacks are an opportunity to a more positive view in the sector.


Given expectations for even more rate hikes this year than markets are pricing in, gold may be seeing some inflation hedging from traders who believe central banks are not doing enough to reduce price pressures. Meanwhile, recent market volatility and geopolitical concerns surrounding Russia and Ukraine have boosted demand for safe-haven gold.

For the year, gold is expected to remain range bound with any major upside potential capped as interest rates rise. However, at the same time, market pullbacks will likely sustain the hedge demand for gold, while jewellery and central bank gold demand may provide additional longer-term support. Strong resistance for gold is seen near the $1,900-1,920 zone, while strong support is seen near $1,680 levels.


The Russia-Ukraine tensions will add to near-term support for oil prices. From a fundamental perspective, oil seems to be bullish as demand for 2022 could hit a record high on the back of recovering air travel. The post pandemic demand outstrips supply, and it could go even higher as countries open further. OECD inventories are likely to fall by the summer to their lowest levels since 2000. Moreover, OPEC+ spare capacity is also set to drop to historically low levels of about 1.2 million barrels per day (bpd). This sets a bullish backdrop for oil.


Sector 12 Month Forecast Economic and Political Predictions
AUD 72-75 The outlook for the Aussie in the weeks ahead appears to at the whim of events in Ukraine. Heightened uncertainty works against AUD, but a resolution or de-escalation would be supportive. With disciplined risk management, as always, opportunities may arise.
Gold Hold

$US1500-/oz- $US1900/oz

The main driver of higher gold prices has been Vladimir Putin’s threat of a forthcoming invasion of Ukraine

Gold will likely face two key headwinds during 2022: higher nominal interest rates & a potentially stronger dollar. However, the negative effect from these two drivers may be offset by other supporting factors, including: high, persistent inflation, market volatility linked to COVID, geopolitics, robust demand from other sectors such as central banks and jewellery etc.
Commodities BUY

The aluminium market is heading into a period of structural deficits and there is no quick fix to resolve this; this should see prices trading higher.

A significant number of commodities will enjoy strong demand growth on a 20-year horizon and can be dubbed the ‘Commodities of the Future’. They are copper, nickel, aluminium, lithium, cobalt, tin, rare earths, metal scrap and green steel.
Property BUY REITs provide reasonable protection against inflation because rents are not as sticky as other prices. Long term leases typically have inflation protection built-in, and shorter-term leases are based on current price levels. Finally, as owners of real assets, REITs typically enjoy an appreciation in portfolio value along with the price level.
Australian Equities Buy We retain a preference for Australia over global equities on a 6–12-month view. Australia’s recent sell-off is looking overdone in a relativity sense. Australia has a lower tech exposure and should offer more “valuation” protection from rising rates via its large financials and resources exposure.
Bonds Remain short duration

I prefer inflation-linked bonds as I see risks of higher inflation in the medium term.

Markets have really struggled with a secular shift in inflation, wages, term risk premia and ultimately nominal government bond yields. Once the market prices in sufficient monetary policy tightening, especially within the context of the highly indebted housing mortgage debt in Australia, opportunities exist to take advantage of overshoots by adding back in duration.
Cash Rates Underweight Cash & bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.10%.
America Underweight

The more hawkish Fed is pushing real yields higher, which pressures the high market multiples of growth names and could lead to a correction

Ahead of the Fed raising rates, equity market investors appear to be moving from growth stocks into value stocks and could also see small-cap stocks suffer, U.S. banks are set to benefit from higher rates. Some forecasters are predicting the Federal Reserve will increase interest rates five, six or even seven times over the course of 2022.
Europe Neutral

European markets are already pricing chunky geopolitical risks, but there is scope for risk premia to rise further across all sectors, if a conflict breaks out between Russia and Ukraine

European equities ended January down as higher inflation, the US Fed’s hawkish shift, and tensions with Russia weighed on European stocks. While valuation gaps within sectors have narrowed slightly in January, they are still at extended levels and nowhere near long-term norms.
Japan Accumulate

Japanese stocks fell in January amid rising concerns over the outlook for interest rate hikes, quantitative monetary tightening in the US and a rapid increase in the number of domestic Covid cases.

Valuations remain supportive and compare favourably with other developed markets, and earnings momentum is positive. However, the unwinding of global monetary easing will accentuate the importance of bottom-up stock picking, particularly in identifying companies that can grow earnings over the mid-term.
Emerging markets Start Buying Strong global growth should be supportive for EM equities, particularly commodity exporters; however, the economic environment and growth outlook is more bifurcated across emerging market equities than across developed world equities.  That said, we believe investors can be tactical in adding to selected emerging markets across Asia, where we are seeing attractive valuations.
China BUY Chinese policy seems to have shifted marginally towards stimulative measures. The PBOC cut both its one-year and five-year loan prime rates. Given the government’s constrained spending in 2021, it has scope for more fiscal stimulus, although is handicapped by the ongoing slowdown in land sales, which is restricting the money local governments can raise to spend on infrastructure.



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