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MAC Monitor — January 4, 2022

Multi-Asset Class Risk Monitor Highlights | Week Ended December 31, 2021

  • Easing concerns over Omicron give bond yields and share prices a year-end boost
  • Hawkish Bank of England lends support to the pound
  • Portfolio risk falls as asset-class volatilities ebb

Easing concerns over Omicron give bond yields and share prices a year-end boost

European bond yields ended 2021 on a two-month high, following a sharp rise in the last three weeks, as stock markets on both sides of the Atlantic reached new peaks in the final days of the outgoing year, amid subsiding concerns about the severity of the new Omicron coronavirus variant. The 10-year Bund benchmark climbed almost 20 basis points between December 10 and December 31, taking the total yearly rise to over 0.4%. Increases were even more pronounced in the same-maturity British Gilt rate, which gained 75 basis points compared with the previous year-end, as the Bank of England went from telling commercial banks to prepare for negative interest rates at the start of the year to initiating a new hiking cycle by raising its base rate from 0.10% to 0.25% in a surprise move on December 16.

Rising inflation expectations were the most important driver behind both monetary-policy adjustments and surging sovereign yields. Especially in the US, the 0.57% year-to-date rise in the 10-year US Treasury yield exactly matched the increase in the corresponding breakeven inflation rate. The surge in long term inflation expectations was even more pronounced in the Eurozone, with breakeven rates nearly doubling from 0.94% to 1.85%. However, the European Central Bank’s pledge for ongoing monetary support meant that the accompanying rise in nominal Bund yields was much more muted.

Please refer to Figure 4 of the current Multi-Asset Class Risk Monitor (dated December 31, 2021) for further details.

Hawkish Bank of England lends support to the pound

The British pound concluded 2021 on an upbeat note, rising 2.5% against the US dollar in the three weeks ending December 31. The stronger exchange rate reflects a changed monetary policy outlook, with the Bank of England now expected to raise its base rate by another 75 to 100 basis points over the next 12 to 18 months. In comparison, short-term interest-rates futures markets in the United States predict an effective federal funds rate of just over 0.75% by the end of 2022, while implying a probability of around 70% that the Federal Reserve will have raised its target corridor to at least 75-100 basis points by that time. That said, the pound was still around 1% in the red compared with the start of the year and down 4.7% from its 2021 peak at the end of May.

The euro, meanwhile, lost 7% against the dollar and 6% against the pound last year, reflecting the more dovish stance of the European Central Bank, whose governing council members have stressed repeatedly that no interest-rate hike is in the cards until at least the end of 2022.

Please refer to Figure 6 of the current Multi-Asset Class Risk Monitor (dated December 31, 2021) for further details.

Portfolio risk falls as asset-class volatilities ebb

Predicted short-term risk in Qontigo’s global multi-asset class model portfolio stood at 7.4% on Friday, December 31, 2021, compared with 7.8% three weeks earlier. This was primarily the result of declines in FX, equity and interest-rate volatilities, although some of the benefit was offset by a positive interaction of share prices and exchange rates against the US dollar—especially the British pound. As a consequence of the latter, non-US developed and emerging-market stocks saw their combined percentage risk contribution go up by 3.4%. The intensifying countermovement of share and bond prices, on the other hand, meant that sovereign debt and high quality, USD-denominated corporate securities actively reduced overall portfolio risk, alongside JPY cash.

Please refer to Figures 7-10 of the current Multi-Asset Class Risk Monitor (dated December 31, 2021) for further details.