Asset allocation: Remaining cautious at the start of the year

The November “rally in everything” came to a sudden end in December, when equities as well as fixed income instruments posted negative returns. Commodities, on the other hand, did relatively well; both gold and copper rose.

Central banks slowed the pace of rate hikes, but they spoiled the year-end party with their hawkish comments. The European Central Bank sounded especially hawkish, which prompted us to push up our expectations for the terminal rate from 3% to 3.5%, despite the growing number of signs, including December CPI numbers, that headline inflation has passed the peak. Fed Chair Jerome Powell, from his side, wants to see the US labour market cool off, which will need more policy tightening. We expect the Fed to reach a terminal rate of 5%-5.25% in Q1 of this year. The biggest surprise came from the Bank of Japan, which expanded the band on the 10-year government bond yields from +/-25bp to +/-50bp. This looks like the BoJ’s first step towards policy normalization and eventually towards abandoning its yield curve control policy.

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