More questions and fewer answers
Inflation and monetary policy
Outlook still mixed
Investing in the UK
Investing in Climate Change
Inflation and monetary policy
Figure 1 Fund managers are losing confidence in the central banks
As fierce arguments rage on this topic (including the nature of inflation itself) fund managers surveyed by Bank of America have clearly become decreasingly optimistic (Figure 1). A chart from the July Survey showed that only 20% of respondents expected inflation to persist. The key determinant will be Consumer Demand in the advanced economies and there is still insufficient evidence that it will step up to new heights. Nevertheless, CPIs around the world are still increasing and, because of the way they are reported, will remain above official targets for at least the next 12 months even if pricing pressures start to abate as is still widely expected. It may take time but a combination of clearing backlogs and switching to new more domestically-oriented supply chains will alleviate and may even reverse the more extreme price rises. In the specific case of fuel prices, although the initial impact is inflationary, unless the price rises fall back they will act like a tax and restrict demand.
In fact, market fretting and betting has moved on from whether or not there is inflation to what if anything central banks can or will do about the exceeding of their targets. It has to be said that there is not a lot of confidence in the central bankers and they are widely expected to make policy errors that will damage economic growth either by tightening too little and too late so that surging inflation will force them to crack down hard later or by tightening too much too soon.
Ironically, having abandoned the optimism associated with the ‘reflation trade’ in mid-summer, those who now subscribe to either pessimistic view on central banks’ error seem willing to pursue the same investment strategy: i.e. positive in respect of equities and wary of yields but still buying bonds if bound by a mandate. It is also worth asking what difference monetary policy can make to the supply bottlenecks and fuel shortages that are forcing up the CPIs.
Figure 2 Risk-free investments?
Much of the criticism of the central banks, directed with or without hindsight, is indeed justified and new thinking and new models are much needed. However, it has been evident for some time that, for a variety of reasons, most central banks (with the important exceptions of the ECB and BoJ) do want to stop buying ever more government bonds anddo want to raise rates in their quest for ‘normality’. In fact, several are already starting to do so. Rampant price rises have forced the hands of the policymakers in some developing economies to hike hard and fast while those in the advanced economies clearly wish to move more gradually and raise rates by not so very much at all. The ‘Anglosphere’ central bankers clearly swap notes even if they do not all move at the same time. The Reserve Bank of New Zealand has already hiked its OCR to 0.5% earlier in October and for the first time in 7 years. The Bank of Canada has announced an immediate halt to its bond-buying programme without tapering and given strong hint of the first hikes being brought forward to Q2 next year. The Reserve Bank of Australia has formally abandoned its experimental policy of intervention to cap shorter-term yields. The Fed has finally announced tapering of $15bn in each of November and December from the previous $120bn asset purchase programme and made clear its determination to delay rate hikes.
The BoE was widely expected to hike by 15bps but instead opted neither to hike nor taper and has come across as more anxious to take the steam out of the ‘4 hikes by June’ speculation. In fact, none of the central banks seems to want to take rates much above 1.5% any time soon and even the famous Fed ‘dot plot’ projections draw the line at 3% over the ‘longer run’.
Currently there is a lot of speculation, using leverage and derivatives in the bond markets that has little to do with inflation. Any persistent instability (Figure 2) could yet force the hands of the central bankers. It would be an irony if whatever policy decisions they take may turn out not to have had much direct impact on the CPIs that will probably fall back in any case.
Figure 3 From pandemic to endemic?
Outlook still mixed
The catch up in data collection since COVID-19 struck is still distorting the numbers, especially year on year comparisons. This makes it more difficult than usual to identify trends amidst all the anecdotal evidence and ‘spinning’. The statistics on the pandemic itself still do not provide answers to some fundamental questions. At least the number of daily fatalities from COVID-19 appears to be heading lower (Figure 3), subject always to the non-emergence of a lethal new variant. There is still a long way to go with 5 million deaths so far and still counting but evidence in Western Europe (not yet in Eastern Europe or the UK) suggests that the virus will downgrade to ‘endemic’, meaning it will still be present in populations around the world, as are strains of the common cold and influenza, and still represent a major health risk but no longer on a mass scale. If the downgrade sticks, the global economy should recover further.
Some other things are becoming clearer:
The economic recovery has gone well in advanced economies but many developing economies are struggling, thereby casting doubts about much further global progress in the next two years.
GDP data is much less even than was first expected. The Q3 numbers for the US and Germany were disappointing but should get better in Q4 while France, Italy and the UK reported more progress in Q3. China’s economy appears to be faltering by its own standards while India’s recovery is building momentum
It may only be a short-term trend, but judging by the number of vacancies, many workers, especially in the US, seem in no rush to go back to low paid jobs while others seem willing to trade avoiding commuting against pay. Overall, however, Employment numbers are encouraging
Generous benefits and the ending of lockdowns have so far boosted Retail Sales in US but elsewhere consumers seem reluctant to spend far less borrow…….except on houses.
The recovery in demand after lockdowns has exacerbated supply chain disruptions with shortages leading to sharp price rises and holding back further growth
An extraordinary combination of extreme weather together with mechanical and tactical production shortfalls around the world has led to surging fuel prices feeding through to consumer prices.
Sentiment in the global Manufacturing Sector was quick to shake off pandemic gloom and Industrial Production has duly recovered but there are signs of strain in China and other manufacturing economies. Meanwhile, the Services Sector is still in strong recovery mode, especially in the US, UK and even in China despite the draconian Covid curfews
Business optimism has been helped by generally buoyant earnings during 2021 but there are doubts as to how sustainable this might be or how much new investment may result if consumers in the advanced economies remain unwilling to return to borrowing and spending as they did before the crash in 2008.
But, of course, there is always inflation to argue about………..
Figure 4 Tax and spend strategy
Investing in the UK
Chancellor Sunak’s budget was more about politics than economics and suggests that a discussion on the attractiveness of UK equities, fixed interest and the pound seems appropriate in the light of various developments:
The UK economy appears to have recovered from the lockdowns more quickly than was expected but the Office for Budget Responsibility (OBR) has estimated a hit of 2% to long-term productivity.
The Government seems determined to pursue a strategy against COVID-19 of herd immunity through mass vaccination and high infection rates.
The risks appear to be growing of a suspension or permanent ending of the Trade and Co-operation Agreement with the EU.
The OBR has estimated that the Brexit deal, assuming the TCA remains in place, will lead to a 15% reduction in trade with EU and consequently a 4% reduction in long-term productivity.
The OBR has reduced its forecast of government borrowing by £60bn .
Sterling strength appears to be deterring foreign investment in UK assets. UK equities are trading at much lower P/E ratios than those in other advanced economies and not just the ‘overvalued’ US.
The question now is: which is more likely to change: the value of the pound or investor appetite? Only Mr & Ms Market know the answer and they do not appear to be Anglophiles.
Figure 5 Proposed statutory reporting obligations for UK companies
Source: Task Force on Climate Related Financial Disclosures
Investing in Climate Change
Amidst all the publicity surrounding COP26 momentum really is building for the implementation of measures and standards that will impact companies and their investors.
The political case for action has been settled with few climate change deniers in power around the world. Governments everywhere are actively developing programmes while hesitating over their economic, social and political impact. The unresolved issue is who pays for what: rich countries, government, businesses, consumers or just somebody else.
Public and private investment in developing new technologies is increasing rapidly.
Following on from its role in promoting the international agreement on a minimum corporate tax rate, the OECD is now working on global carbon pricing. Meanwhile, the EU is planning a carbon border tax.
The UK is introducing from next April new disclosure requirements on climate-related information by public companies, banks and insurers with over 500 employees. The new obligations follow the guidelines of the Task Force on Climate-Related Financial Disclosures on global warming, forest fires, coastal flooding and financial impact of the transition to a lower-carbon economy (Figure 4). At COP26 an international standard was announced.
The Carbon Disclosure Project is reporting a rapid rise in the number of companies around the world recognising potential liability risks. Figure 5 provides a sectoral analysis.
Figure 6 Climate Change risks and costs are already here
Disclaimer: This report is compiled from sources the author believes to have been reliable but it may not be complete or accurate on any particular subject. All opinions, estimates, and analyses are or were those of the author at the date of issue and are subject to change without notice. Accordingly, the author makes no representation or warranty on any subject discussed in the report; nor does he accept responsibility or liability for any claim, loss, damage, expense or cost arising from reliance upon its contents.