Market Update 6th February 2023

Don’t grumble, give a whistle

There was a lot to digest last week. After being served up more economic data than is healthy for anyone, it is no surprise that markets have a degree of dyspepsia. The data is inconsistent, occasionally contradictory and definitely confusing. The market mood, however, is undoubtedly brighter and, despite the occasional involuntary belch, has a new determination to look on the bright side.

This may seem odd after a week in which interest rates rose, yet again, in the USA, UK and Europe, and the market’s optimism is overdue a test. But let us summarise the past week. In the United States, the Federal Reserve raised interest rates, as expected by a quarter point. The significance of this should have been that this rise was much smaller than the previous series of three-quarter point rises. This was meant to mean that the Fed would indicate that this would be a peak, or at least very close to being so. But oh no. What we had instead was the message that they intend to keep adding quarter point increases and have no intention, yet, of dropping the tough-guy image.

On Friday, they seemingly had justification for this. The monthly increase in employment in January was reported to be 517,000. The market was expecting fewer than 200,000. American businesses, according to this, are still hiring workers at a frantic pace. This, however, is firmly contradicted by the latest Purchasing Managers’ Index of 46.8, a number that would usually indicate a moderate economic contraction.

Let us move onto the UK and the Bank of England. The Bank has previously let the markets understand that it was in a bit of a grump and was in no mood to take any further chances with that dratted inflation. Hence the last few months’ rise in the pound, in anticipation of more rate rises to come. The Bank duly delivered the expected half point rise in rates, but quite unexpectedly suggested that it is starting to be concerned by an inflation undershoot towards the end of 2024. Where did that come from? Precious few people saw that coming, and certainly there was no prior warning from the wood-panelled walls of Threadneedle Street. Nonetheless, the combination of the large fall in European gas prices, the easing of supply chains (especially from China) and lower gilt yields has persuaded the Bank that the UK now faced only a shallow recession and a much quicker fall in inflation.

At this juncture, we should backtrack to January 4^th and a speech made by Prime Minister Rishi Sunak. I have dug out the official text, and quote this excerpt: “So I want to make five promises to you today. Five pledges to deliver peace of mind. Five foundations, on which to build a better future for our children and grandchildren. First, we will halve inflation this year…”. Rishi’s maths were taken to be a halving of the headline rate from a bit over 10% to something around 5%. Four weeks on from this, the Bank of England is now predicting a year-end inflation rate of 3%. Who should we now thank? Is it Rishi’s government? Is it the prudent actions of the Bank of England? Or is it the lower gas price and China’s renewed ability to load container ships?

Perhaps it does not really matter. Hopefully readers of this column will know that we have argued for sometime that inflation was likely to fall, possibly a long way, before 2023 is through. The MPC’s acknowledgement of this is very welcome. I have been highly critical of the Central Banks in this inflation cycle, and so I should acknowledge when I believe that they have done something right. The change in guidance is wholly sensible. It will take time to have much of an impact: if the Bank’s new forecasts are to be believed, inflation will be 8% in the summer, but will fall very quickly thereafter. That will be, of course, when the increases in gas and electricity prices start to drop out of the annual calculations.

Market sentiment will ebb and flow. The Fed’s public determination to keep raising American rates will weigh heavy for a while. But if the markets really are finding the bright side, then we may be only one weak payroll number away from a turning point.

Jim Wood-Smith – Market Commentator and Head of Climate Transition

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