By Renée Friedman, PhD
The week in summary:
Welcome to Macro Insights #7. Over the past week we’ve seen US treasuries fall then rally as the higher than expected US CPI at 6.2%, above the expected 5.8% and the highest since 1990, led to US stock markets closing lower after 19 weeks of highs. Nonfarm payrolls increased by 531,000 after large upward revisions to the prior two months. The unemployment rate fell to 4.6%, while the labor-force participation rate was unchanged. The rise in employment, the fall in unemployment, and the rate of CPI growth have all spooked some market pundits to think that the Fed will have to speed up its taper and even begin to think about a rate rise as early as June 2022. The dollar gained against the Euro and the GBP. Concerns about the stickiness of inflation in the US are likely to rise, especially as fiscal expenditures start to rise again with the passing of the $1.2 trillion Infrastructure bill last Friday which also saw oil and base metal prices rise on the prospect of increasing demand. Global stock indices were largely down (with the notable exception of the Hang Seng) fueled by fears over the rising inflation risk and the impact this will have on companies moving forward and how soaring oil prices will affect margins. Gold was at its highest level since June and Bitcoin also regained lost ground to hover near the $65,000 mark.
In the UK Bank of England governor Andrew Bailey had to defend the 3 November decision not to raise rates after he, and several other members of the FOMC, had intimated that a rate rise was on the cards in November with further tightening ahead. However UK output grew 1.3% in Q3, less than the 1.5 % forecast by the Bank of England, due to downward revisions to August and July estimates. Output was still 2.1 % below its pre-pandemic levels, a larger gap than any other G7 country. The GBP has fallen to its lowest against the USD since December 2020.
Things to look out for this coming week:
- In Europe on Friday look out for industrial production data. On Sunday preliminary y/o/y 3Q GDP will be released. On Monday there will be data on the Eurozone’s trade balance. On Tuesday we will get Eurozone unemployment data with unemployment changes y/o/y and q/o/q. We will also get preliminary Q3 GDP q/o/q. On Thursday there will be CPI data.
- In the US on Friday we will have the Michigan Consumer Sentiment Index providing insight on how US consumers are feeling about inflation and the economy in general and also on Friday the Fed’s John Williams will be speaking. On Tuesday there will be capacity utilisation which indicates overall growth and demand in the U.S. economy. On Wednesday look out for the ever important retail sales numbers as consumer spending has a significant impact on GDP. We’ll also have building permits and housing starts data on Wednesday. On Thursday we have initial jobless claims and the Philadelphia Fed Manufacturing Survey.
- In the UK on Tuesday we’ll have the claimant count rate and claimant count change, average earnings and the ILO unemployment rate. Markets will be looking closely to see the impact the end of furlough has had on unemployment rates; no change or a falling rate will be a strong sign that the recovery is still on track and will put more pressure on the Bank of England to act in December so as to prevent any risk of inflation expectations starting to hit wages in a tightening labour market. On Wednesday we’ll see just where inflation is heading with the release of the consumer price index, the retail price index, and the producer price index.
Getting the foundations right
Infrastructure investment may be about to have a bit of a moment; a growing population, increasing global urbanisation requiring new planning and the focus on Smart Cities, the need to replace aging physical and IT infrastructure, the need to respond to the changing lifestyle needs of aging populations in some countries and the increased focus on sustainability as evidenced by promises made at COP26 including on clean energy, are all likely to contribute to renewed interest in this sector.
On Saturday, 6th of November, the US House of Representatives approved President Joe Biden’s $1.2tn bipartisan infrastructure bill in a 228-206 vote. It passed with 13 Republicans joining most of the Democratic caucus. This was a major victory for the US president following months of Democratic party infighting. The bipartisan bill will see $260bn invested in transportation and transit, $90bn in clean technologies, $84bn in water infrastructure and $100bn in digital infrastructure. This follows the EU’s NextGen (€360 billion in loans and €390 billion in grants) and green energy initiatives (worth €785 bn) in the multiannual financial framework (2021-2027).
But it isn’t just the traditional infrastructure stocks that will benefit, e.g.,the upstream energy and materials stocks like aluminium, lithium, for battery production critical in new Smart Cities transport infrastructure, steel and cement. The increasing focus on green energy and sustainability should benefit not just the builders of roads, bridges, new pipelines and waste treatment facilities, but also those engaged in the design of “clean” and green digital infrastructure, e.g., engineering companies that design climate responsive and resilient buildings, clean technology providers, including those in the water sector and those focused on carbon capture and storage, those that allow for data connectivity such as sensor based infrastructure that can be used in Smart City design for things like traffic monitoring and control, and digital infrastructure providers as well.
So with all this promise of growth, is there any hitch that may hit investors? It really comes down to not just public commitment (and the ability to raise private cash to help fund) but also inflation. Infrastructure stocks are usually viewed as partial inflation hedges as most traditional infrastructure assets have an explicit link to inflation because the rates charged to use infrastructure assets are usually inflation-linked whether they are determined by regulators, concession agreements, or long-term contracts. However, inflation can take the shine off infrastructure stocks; the same inflationary pressures causing raw materials prices to rise hits downstream companies that are involved with processing, refining, packaging,and distributing natural resource–based products, which can negatively impact margins and valuations. And it can also hit infrastructure assets that are linked to GDP growth; lower growth generally means lower usage of things like airports, toll roads, and ports. The real effect inflation has on infrastructure today has more to do with inflation expectations and whether or not these are indeed changing. Increasing inflation expectations typically lead to central bank’s responding by increasing interest rates. Infrastructure projects tend to provide a term structure of cash flows, which are discounted using a term structure of interest rates to which a risk premium is added to reflect the uncertainty of future payments. Therefore there is a direct correlation with interest rates and inflation expectations.
As inflation expectations and risk are rising in the US and across EMEA, investors will have to weigh very carefully the short and long term benefits investment in the broader range of infrastructure stocks may bring them vs what they think central bank policies across these regions will be over the next 1-2 years.
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