• April 3rd, 2023
• By Midsilver Investment Limited

During the review, financial markets built on prior gains. As inflation indicators started showing a downward trend and policy tightening decelerated in the early part of the review, there was an easing in financial conditions. This led to an uptick in the valuations of risky assets, primarily due to perceptions of diminishing risks. The market seemed increasingly confident about impending rate reductions, even though central banks expressed a cautious stance regarding future policy. The US dollar saw a decline, giving a boost to assets in emerging market economies (EMEs). However, as the period wrapped up, the markets showed vulnerability to information that tested the optimistic sentiments of investors.

The anticipated future policy rate trajectories by investors were somewhat misaligned with the statements of central banks. Many major central banks showed a slower approach to monetary tightening but still conveyed reservations about future interest rates, especially considering the robust nature of labor markets. Yet, the market kept indicating, through interest rate futures, its belief that rate increments would conclude this year, paving the way for notable rate reductions that might continue until 2024.

Government bond market dynamics continued to be influenced by growth perceptions, inflation, and the corresponding policy reactions. In Japan, there was unrest in the fixed income sectors, with investors evaluating the yield curve control (YCC) strategy. The central bank's consistent open market activities helped stabilize the market and manage the rising momentum of bond yields.

Risky assets marked an increase, and the US dollar declined for most of the review period. However, towards the end, fresh news disrupted the market's positive expectations about policy directions. While there were periodic sell-offs, stock markets overall posted gains, even against a backdrop of a rather muted earnings forecast. The simultaneous decrease in market volatility indicators hinted that positive risk perceptions were driving valuations. Similarly, credit spreads shrank further due to falling default risk perceptions, and January witnessed a revival in corporate bond issuance. However, US data released in February nudged investors to expect potential policy challenges ahead. This resulted in a slight uptick for the dollar and a partial rollback in gains from risky assets, causing a temporary halt in their divergent trend from the subdued bank lending in major advanced economies (AEs).

EMEs saw a mild relaxation in financial conditions, which largely reflected trends in AEs. Bond yields took a downward turn, given a positive environment marked by steady growth and declining inflation. Equity markets experienced more substantial shifts, impacted by the fluctuations in the US dollar. China's unexpected decision to abandon its zero-Covid strategy breathed new life into its stock market, which in turn boosted the performance of risky assets in economies closely tied to China. However, this shift couldn't reignite the stagnant portfolio inflows into China, whereas most other EMEs witnessed stabilized or even enhanced inflows.