June 24 2022
Not a week seems to go by where inflation isn’t in the headlines. This week we saw the release of the latest figures for the UK, with CPI coming in at 9.1%, in line with expectations. Under the bonnet, the rate of inflation was higher across most categories, in particular housing & utilities, transport and food & non-alcoholic beverages.
The squeeze on disposable income is certainly having ramifications. Consumer confidence, also reported this week, fell to a record low, fuelling concerns of a pullback in consumer spending. The impact on retail sales, it could be argued, is already being seen, with sales (excluding fuel) down 5.7% year on year. This was worse than the consensus forecast of -5.1%. We have seen the first round of strikes by railway workers as they push for higher wages. Following the strike announcement issued by British Airways staff set for the summer it would be foolish to rule out more. A ‘summer of discontent’ is potentially on the horizon.
In the US meanwhile we continued to see evidence of an economic slowdown. The S&P Global Manufacturing PMI flash figure for June came in much weaker than expected, reading 52.4 versus a forecast of 56. A figure below 50 suggests contraction within the sector. The Services equivalent was also weaker than forecast, at 51.6 versus 53.
The Atlanta Fed GDPNow model, which provides a “nowcast” of the official estimate prior to its release, now forecasts 0% real growth for the 2nd quarter of this year. With the economy having contracted in the first quarter, investors will be keenly watching for further weakness in this Q2 estimate, with two consecutive quarters of negative growth representing a technical recession.
Despite concerns over growth, central banks are keeping their foot down in terms of tackling inflation. Further interest rate hikes are expected from the US Federal Reserve, the Bank of England, ECB and the Swiss National Bank. The Bank of Japan continue to abstain, committed to holding interest rates and buying Japanese Government Bonds (JGB’s) to cap the 10 year yield at 0.25%.
No news on the Bank of England reducing the size of their balance sheet just yet, but the US Federal Reserve are soon to embark on a $100bn a month reduction program, tightening liquidity further. This move has been well signalled. Central bank balance sheets as a percentage of GDP however have never been as high and they have some way to go before they return to pre-COVID levels, never mind pre the Global Financial Crisis. Will economies and markets ever be strong enough to allow that to happen?
There are signs that monetary tightening is creating stresses within the financial system. Last week we saw the ECB call an emergency meeting to discuss the potential for a new anti-fragmentation instrument, aimed at providing consistency across borrowing costs of EU members. This week we have seen the Argentina five year credit default swap trade at an all-time high.
This leaves central banks in something of a predicament. They are under substantial pressure to bring inflation under control, whilst not bringing economic growth to a standstill. Until inflation is under control however we are likely to see heightened volatility across investment markets.
There is an old adage of “sell in May and go away” when investing in equity markets. Assuming you left that till the last day of the month, it is certainly one which is playing out, with the FTSE All Share down 7.79%, the S&P 500 8.14% and Eurostoxx 50 9.31%, in price only, local currency terms. To date it would therefore appear to be playing out. It could be a long summer ahead of us however and therefore a little too early to call out its success this time around.
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