The last week in markets, as is often the case, was totally dominated by the US economy and monetary policy. In this case it was an encouraging inflation print on Wednesday, followed by the US Fed’s decision to keep rates on hold the next day.  Fed Chair Jerome Powell struck a cautiously optimistic tone about the state of the economy and progress on bringing down inflation. He noted recent data showing inflation easing from highs without a significant rise in unemployment. Powell stated, "We are highly attentive to the risks that high inflation poses to both sides of our mandate, and we are strongly committed to returning inflation to our 2 percent objective."  

While Powell emphasised that the Fed is not declaring victory prematurely, saying "It is far too early to declare victory, and there are certainly risks”, markets rallied strongly on Powell's remarks, interpreting them as confirming expectations for potential Fed rate cuts in 2023. Most markets ended the week up a few percent, while many cyclical and interest rate sensitive sectors here and abroad surged by four or five percent, and global smaller companies were up 6% for the week.  Bond yields declined, with 10-year rates heading below 4% in the US and approaching the same level in Australia, while futures traders boosted their odds of rate cuts as early as May, something which Powell wasn’t really intimating if one listened closely. In fact, he indicated additional policy firming may be appropriate if needed to sustainably return inflation to target. He was also at pains to point out that key data reports on inflation and jobs in upcoming months will likely determine if markets' soft landing hopes are realised or thwarted, but the media has already framed this conference as a ‘Powell Pivot’ based on hopes of a soft landing early next year. Just about every comment was couched in caution, such as "while we believe that our policy rate is likely at or near its peak for this tightening cycle, the economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2 percent inflation objective is not assured." In reality, it is the change in tone from being relatively dour (or hawkish) 6 weeks ago that has given rise to the uptick in market sentiment and many column inches.

Last week’s price action means that fixed income government bond yields are now well down from autumn highs, boosting prices across the risk spectrum and even in more speculative corners of debt markets like high-yield corporate credit. Having been down by more than 10% at one point in the year, most bond sectors are now flat or in positive territory. For equities, this also caps off a broad-based rally over the last few weeks, with small and mid-cap stocks outperforming larger companies, and cyclical sectors like financials and industrials being standout performers as recession fears have ebbed. Rate-sensitive areas of the market including real estate, utilities and tech stocks have also done well. Emerging markets and Australian equities have likewise rebounded recently but remain only just in positive territory for the year, which also reflects the mixed picture in commodity markets, with oil prices well off 2022 peaks but industrial metals and gold still recovering lost ground. The U.S. dollar has also weakened across the board in recent weeks which should help the global economy but suppresses returns for the unhedged Australian overseas investor.

Putting all this together, the rally of the last six weeks – should it be sustained – will leave diversified Australian portfolios up between four and twelve percent depending on the risk profile, whereas in October those numbers were more like one to five percent and heading south.