Risky assets to ‘shrug off’ Ukraine, rate rises

The global share market has mostly adjusted for rate hikes and a Ukraine conflict may prompt a ‘dovish reassessment’ by central banks, according to JP Morgan.

JP Morgan says markets have priced in six rate hikes in the Fed funds rate by December. Picture: Getty Images / AFP

Global sharemarkets will stare down a potential conflict in Ukraine and expected US monetary policy tightening as share prices have mostly adjusted for rate hikes and conflict in Ukraine would likely prompt a “dovish reassessment” by central banks, according to JP Morgan.

In its latest global asset allocation report, the US investment bank’s strategists said risks were “now tilted towards a dovish reassessment” by central banks.

That assessment came even as they projected a “strong cyclical recovery” this year as easing Covid restrictions lead to increased mobility, releasing pent-up demand.

“Markets have been volatile recently and sentiment dour as investors grapple with monetary policy normalisation and geopolitical risks,” said JPM strategists led by the bank’s co-head of global research, Marko Kolanovic.

“However, we believe risk asset markets have mostly adjusted to monetary policy shifts by now, short-term rates markets have likely moved too far versus what the central banks will ultimately deliver in hikes this year, and a China policy pivot can offset a good part of developed markets’ central bank tightening impact.”

The money market now fully expects six US rate hikes to boost the Fed funds rate to a midpoint of just over 1.7 per cent by December from the current record low target range of zero to 25 basis points adopted after markets tanked at the start of the pandemic.

In Australia, the market has priced in a 1.26 per cent cash rate by December from a record low of 25 basis points now. After recent Reserve Bank communications, CBA economists predicted the first RBA rate hike would now come in June after it adopted an “explicit easing bias” in May.

But while noting the risk of conflict in Ukraine was “high” amid reports that Russia had moved its troops into offensive positions near the border, Mr Kolanovic said it “should have limited impact on global equity markets and would likely prompt a dovish reassessment by central banks”.

“We expect risky asset markets to rebound as they digest these risks and sentiment improves, aided by inflows from systematic investors and corporate buybacks,” he said.

While the US S&P 500 share index has fallen 2.3 per cent and Europe’s STOXX 600 2.4 per cent since Friday’s US warning that Russia was poised to invade Ukraine, Australia’s ASX 200 was little changed, even after iron ore futures dived on fresh regulatory pressure from China.

JP Morgan kept a “pro-risk view with a strong cyclical tilt in our model portfolio, including aggressive overweight positions in equities and commodities funded by a large underweight in bonds”.

“We continue to favour value, cyclical and higher-beta market segments given their still cheap valuations and light positioning, and since they are beneficiaries of rising bond yields and higher commodity prices,” Mr Kolanovic said.

“We also retain our commodities overweight, focused on energy, given our supercycle thesis and geopolitical risk asymmetry.”

In his view, a de-escalation in Ukraine would likely produce only a modest drop in crude oil prices, while a disruption to oil flows could easily send prices over $US120 a barrel.

Moreover, the view that inflation would prove persistent rather than transitory supported “aggressive commodity overweight, and bond and credit underweights”, as well as preferences for the energy, materials and financials sectors within the equity market.

“Even as central bank hawkishness has ramped up, with market assumptions perhaps having gone too far in some cases, the silver lining to the recent pain is that equities are better equipped to handle it going forward,” he said.

“Bearish sentiment seems overdone as the conditions for ‘late cycle’ or recession are not met. Even as inflation has dented sentiment, ultimately the consumer is healthy given the strong jobs market.”

With bond yields set to keep moving higher, JP Morgan favoured cyclical exposures in the value end of the market, in emerging markets, China, the UK, and the eurozone.

Europe should benefit from its first above-trend growth since 2017. The UK is seen as a hedge against multiple compression from rising rates.

And with China’s market down 40 per cent from its February 2021 highs and “incipient signs of a pivot” away from policy tightening, both direct exposure to China or indirect via global cyclicals such as mining and autos was favoured.

Earnings delivery has been “healthy across the regions, and any weakness in guidance will likely fade as Omicron rolls over”.

JP Morgan is overweight Russia on valuation and the potential to hedge against rising oil prices.

It sees upside in the MSCI Asia ex-Japan and MSCI Asia Pacific indexes given a “reopening dynamic, supply chains easing, and release of pent-up demand on the back of a China pivot”.