Ear to the Ground

February 17 2023

Here in the UK, a congratulations to the FTSE 100 which breached the 8,000 level for the first time.  Despite weak earnings from Barclays, there were strong earnings posted by Centrica, whose principal activity is the supply of electricity and gas in the UK.  The company, however, is likely to come under attack from the UK public, who are stuck with higher energy costs and are likely to see a material increase in April when the current energy cap expires.

From an UK economic perspective, the key data released this week was inflation, where we saw the consumer price index (CPI) rising by 10.1% year on year.  This was lower than the reading from the previous month of 10.5% and lower than the consensus forecast of 10.3%.  This marked the third consecutive decline in the rate of inflation.  The largest contributors to this were lower rates of inflation in passenger transport and motor fuels. 

Whilst UK unemployment remains low, holding at 3.7%, average earnings including bonuses rose by 5.9%, which was below the reading the previous month of 6.5% and also below consensus forecast of 6.2%.  Conversely, average earnings excluding bonuses rose by a sharper than expected 6.7%, with 6.5% having been forecast.  Ultimately, however, both rates still remain some way below consumer price inflation and therefore the cost of living squeeze for most continues.  This is something reflected in the Asda Income Tracker, issued in conjunction with the Centre for Economics and Business Research, which shows that family spending power was down £23.18 a week, year on year, in December, a 9.9% annual decrease.

In the US we have seen a lift in Treasury yields this week as the market became a little less confident that the Federal Reserve was nearing completion in putting interest rates up.  Two policy setting members have said that they wouldn’t rule out the next rate hike being 0.5% rather than the 0.25% expected by most market commentators.  Indeed, over the last month we have seen a rise in where the market expects the terminal interest rate to be, with data from Charles Schwab and Bloomberg suggesting this has risen from 4.92% to 5.25%.

This is not the only jurisdiction where we have seen this however, with it being evident in Canada, Australia and the Eurozone.  In the latter we have also seen comments from rate setting committee members that they might not be done with hiking just yet, suggesting that some see risk that the markets are underestimating inflation.

In the US this week we also saw the release of inflation data.  This came in at 6.4% year on year, which was lower than the previous reading of 6.5% but higher than the consensus forecast of 6.2%.  Although the rate of inflation in items such as food and used cars continued to fall, the rate of inflation for shelter and energy actually picked up.  There were also signs that inflation was remaining resilient elsewhere, with producer price inflation rising 0.7% month on month, higher than the consensus forecast of 0.4%.

Higher rate expectations has also meant higher short maturity bond yields.  This of course has ramifications in terms of assessing the risk premium across asset classes.  Typically you would expect that fixed income would provide a higher yield than cash due to the credit risk which you are taking on investing in the latter.  Likewise, you would expect the earnings yield (the inverse of the price to earnings ratio), on equities to be higher than that from fixed income.   The yields offered by US 6 month Treasury Bills, short dated corporate bonds and equities have converged with, at the time of writing, less than half a percent between them.  This has been driven by higher interest rate expectations, coupled with a higher valuation on equities as a result of falling corporate earnings.  Perhaps a good time not to have all your eggs in one basket, when it comes to US assets at least.

This article is for information purposes only and should not be construed as advice. We strongly suggest you seek independent financial advice prior to taking any course of action.

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