By Renée Friedman, PhD
The month in summary:
Welcome to our Monthly Macro Insights. November was a challenging month for markets due to concerns over rising inflation and the resurgence of Covid infections. There were significant spikes in Covid rates in Slovakia, the Czech Republic Austria Belgium, the Netherlands, Croatia, Slovenia, Hungary and Germany. The announcement of the new Omicron variant is changing expectations of central bank activity in the US, the UK, the Eurozone and beyond. The expectations that the US Fed would increase its taper rate, with a rate rise now pencilled in by markets for June 2022 and with expectations that the Bank of England would finally raise rates at their December meeting, have suddenly been thrown into disarray.
All of this comes after a month where the growing divergence between US, European and UK markets has been thrown into sharp focus. In the US rising inflation (and inflation expectations) and the re-appointment of the increasingly hawkish Jerome Powell as Fed Chairman, led to the S&P registering a decline of 0.7% and the Dow a drop of 3.7%. Only the technology heavy Nasdaq experienced a 0.25% gain.
In Europe economic data was mixed. Euro area PMI was up 1.6 to 55.8 after 3 months of decline but persistent supply bottlenecks continued to weigh on output, consumer and business sentiment in Germany while French consumer sentiment held steady and business sentiment improved. ECB president Lagarde stayed firm on no rate rises despite inflation across the eurozone's 19 member states currently sitting at 4.9%, the highest on record, and Germany, the bloc's most important member, at 6%, its highest rate since reunification. European equities declined by 2.5% over the month due to rising Covid cases and restrictions being brought back in and government bonds rallied.
In the UK, the situation remains murky. The FTSE All-Share fell 2.2%. Sterling fell over the month.Gilts rallied following the Bank of England’s (BoE) decision to keep rates on hold Even though UK payrolls rose by 160,000 in October, the unemployment rate fell to 4.3% in Q3 and vacancies increased to a record 1.172 million in 3 months to October, retail sales rose 0.8% m/o/m in October, the highest since April, and inflation was running at 4.2%, BoE Governor Andrew Bailey said risks to the U.K. economy are “two-sided”, with slowing growth and rising inflation.
Things to look out for this coming month:
There is still the not insignificant issue of the US debt ceiling to be resolved. U.S. Treasury Secretary Janet Yellen extended the deadline for a potential U.S. government payment default to 15 December from 3 December. In testimony to the Senate Banking Committee she said that “America must pay its bills on time and in full, and if we do not, we will eviscerate our current recovery.” The House of Representatives and Senate have until midnight Friday to pass another continuing resolution that could maintain government operations and avoid a shutdown in federal services through February or March and give Congress more time to finalise its 2022 appropriations bill. The Republicans are unlikely to give way to the Democrats wanting to raise the ceiling in a bipartisan effort, therefore one option may be that the Democrats are forced to do “reconciliation”. This would allow Democrats to lift the debt ceiling without any Republican votes. As this process requires putting forward a specific figure to which the ceiling should be raised, it is an unpopular choice of action as it would limit what Democrats could say they will do in the run up to next year’s midterm elections. Given that the political situation across the US is even more highly divided than in prior “ceiling” debates, investors may need to think about some contingency measures including the further diversification of their portfolio assets.
On 14-15 December the US Federal Reserve meeting will likely discuss speeding up the taper and, given that employment is continuing to move upwards, despite still not being at pre-pandemic levels, the timing of rate rises are also likely to be discussed. It is clear from Fed Chairman Powell’s comments to the Senate banking committee on 30 November and 1 December that the Fed no longer sees price growth as "transitory" as very strong consumer demand and persistent supply chain problems are starting to worry the FOMC about how embedded inflation is becoming in consumer and producer expectations.
On 16 December the European Central Bank (ECB) governing council may announce the end of its pandemic bond-buying plan and outline how regular purchases and interest rates will develop. There are grumbles from some member states, e.g. Bostjan Vasle, an ECB governing council member and governor of the Bank of Slovenia, said that the likelihood that elevated inflation will become entrenched is increasing and that he can’t exclude a shift in expectations and second-round effects on the labor market. There is also the issue of factory gate inflation; it rose 5.4% month-on-month in October for a 21.9% year-on-year surge. The governing board seems, at least at present, more worried about structural labour employment issues in the Euro area, the impact that inflation is having on consumer sentiment, how this is starting to alter inflationary expectations, and what a rise in rates would do to price stability across the very diverse region.
The Bank of England will also be meeting on 16 December to discuss a rate rise after disappointing investors and savers in November.
On 19 December is Chile's second round of elections with the choice between the conservative, harder-right candidate José Antonio Kast vs the more leftist Gabriel Boric. If Kast wins the presidency, Chile could be led by two completely politically opposite institutions: an executive branch controlled by a right wing president and a divided Congress; and on the other, a constitutional convention dominated by the left.
And finally 2021 may go out with a real bang as Hong Kong Legislative elections are currently scheduled to take place on 19 December. This will be highly contentious because of Beijing’s crackdown on opposition politicians and activists. On 30 November a Hong Kong court issued arrest warrants for former lawmaker Ted Hui and ex-district councillor Yau Man-chun for allegedly advocating for others to boycott or cast blank votes in the upcoming legislative election. There are highly likely to be protests and other civil disruptions; expect increasing political tensions between the US, EU, and regional neighbours like Australia if Beijing does indeed prevent or delay the elections again.
Central banks, divergence and backpedalling
The Fed has finally said that current inflation is not transitory. The ECB and the Bank of England have yet to agree although both the UK and the Eurozone are experiencing their highest levels of inflation in decades at 3.8 and 4.9% respectively. ECB President Christine Lagarde continues to insist that the ECB will not be looking to raise rates next year and most probably, not even the year after, as the inflation risk will dissipate once the German VAT hike moves out of yearly calculations (base effects), energy prices stabilise as more supply becomes available , and supply bottlenecks are overcome. The Governor of the Bank of England, Andrew Bailey, seems to vacillate in his view; after virtually promising the market that there would be a hike in November, he backpedalled saying the monetary policy committee (MPC) needed to see how the ending of the furlough would negatively affect employment. It didn’t. So even though the Bank’s new chief economist Huw Pill suggested that the Omicron variant would not deter the Monetary Policy Committee from hiking rates in December,
According to the Organisation for Economic Cooperation and Development (OECD)’s latest forecast global growth is set to hit 5.6% this year before moderating to 4.5% in 2022 and 3.2% in 2023. "The main risk, however, is that inflation continues to surprise on the upside, forcing the major central banks to tighten monetary policy earlier and to a greater extent than projected," the OECD said. Provided that that risk did not materialise, inflation in the OECD as a whole was likely close to peaking at nearly 5% and would gradually pull back to about 3% by 2023. Given this, the OECD said that the best thing central banks can do for now is wait for supply tensions to ease and signal they will act if necessary.
So just why are these central banks not acting on inflation despite investors, consumers and savers expecting them to take action?
There are a number of possible reasons, but the divergence may be due to structural and legal factors. The UK is likely to continue to have labour shortages as foreign workers, put off by Brexit rules and continuing Covid uncertainties, are unlikely to return in numbers high enough to meet demand. This will, at some stage in the not too distant future, lead to higher wages for all groups, not just low earners. In addition, the UK, although an energy producer, imports about half its energy from Europe or has it shipped in as liquefied natural gas (LNG) from countries like the US, Russia and Qatar. However it does not have adequate energy storage facilities; it can store less than 6% of annual demand compared to Germany, France, and Italy, where storage covers about 20% of annual demand. Also in the UK considerations for not taking action may include the UK level of debt: the rise in inflation meant debt interest is higher (as some of it is tied to the retail price index (RPI). However, annual debt interest payments remain at historically low levels despite the national debt/GDP ratio hitting its highest point since the 1960s. A low rate keeps servicing costs low. Another consideration may be how house prices and pension values would be affected by a rate rise.
For the Eurozone the situation is more complicated as, unlike the Fed, the ECB cannot, as noted by Hans-Werner Sinn, who sits on the German economy ministry’s Advisory Council. legally seek to balance the goal of price stability with other monetary-policy objectives. So it looks likely to wait out the problem with the hope that as supply bottlenecks ease by Q3 2022, there will not be secondary labour affects, ie, that trade unions will not have increased wage demands triggering a spiral of rising prices and wages that may continue for several years. Perhaps it is hoping that Euro depreciation, although boosting import prices further, will encourage more domestic Eurozone import substitution.
What is clear is that policies between the big central banks will continue to diverge further to accommodate their unique needs and pre-existing conditions. For investors this means watching out for currency fluctuations across the key currencies (USD, GBP, Euro, and Swiss Franc) and seeking hedging opportunities. They will also need to be wary of bond market volatility as that too has been rising. The key thing for investors will be to pay close attention to the nuances in the messages sent out by the central bankers and to look beneath the Covid bonnet and focus on the underlying economy specific structural issues such as demographics, labour participation rates, and over or undervalued asset prices.
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