Before we get going, some good news to bring you!
Our latest podcast has arrived this week, featuring Ryan Grabinski of Strategas Research Partners, Adam Norris and myself reviewing our forecasts for 2022 and thinking about investment themes for 2023. It can be downloaded or streamed from Apple Podcasts via this link. Reviews so far include “it’s a bit boring” from my 9-year-old son. I feel some quantitative tightening coming to this week’s pocket money…
It’s been a busy week in financial markets, with the Bank of Japan meeting and news from China dominating headlines, while closer to home, UK inflation data continued to ease, but remains at eye wateringly high levels.
After the excitement of their December meeting where the Bank of Japan surprised markets with the change in their Yield Curve Control policy, this week’s meeting was a more subdued affair, to the surprise of some who expected further changes. Bank Governor Haruhiko Kuroda, who steps down in April, suggested that December’s move was only intended to improve the functioning of bond markets. Kuroda said, “we do believe market functioning will improve in the future … the Yield Curve Control is sufficiently sustainable”. However, the Bank of Japan is clearly being tested by financial markets, with the belief that December’s move will lead to a further loosening of policy, most likely once Kuroda’s yet to be announced successor takes up their role. In the meantime, the Bank of Japan is spending huge amounts buying government bonds to keep the yield below 0.5%. Since the December 20th meeting, the Bank has spent 34 trillion Yen ($265 billion) to keep a lid on yields – the equivalent of 6% of Japanese GDP. This does not sound like a sustainable policy. Japanese inflation, at 4%, is now double the Bank’s target and a 40 year high. Japan has spent the past decade desperately seeking inflation, but not this kind of inflation.
In the US, Treasury Secretary Janet Yellen reminded congress of the ‘Debt Ceiling’ which has now been breached. The debt ceiling, which currently stands at $31.4 trillion, has been raised, extended, or redefined 78 times since 1960. The US Treasury is employing “extraordinary measures” to avoid running out of cash given that it cannot now issue new bonds – this should buy some time but by June it is likely a formal increase in the ceiling will need to have been passed by Congress. Given the fractious nature of US politics, a divided Congress, and significant divisions within the Republican Party, this may not be a formality. Republicans are calling for spending cuts; President Biden is not inclined to budge. We’ve been here before in recent years, most notably in 2011, when the US came close to a technical default resulting in market volatility and a ratings downgrade. It’s certainly something to watch out for even if a default remains an unlikely tail risk.
In the economic numbers we saw China publish Q4 GDP data, with the economy growing by 2.9% year on year, ahead of expectations. Growth for the year as a whole was 3%, which was the slowest pace since 1976 with the exception of the first year of Covid in 2020. The impact of the now-abandoned zero-Covid policy was reflected in weak retail sales, down 1.8% year on year but ‘less bad’ than expected. Industrial Production was slightly stronger, up 1.3% year on year. Population data showed the first decline in 60 years, with the Chinese population shrinking by 850,000 to 1.41 billion. Covid was blamed for the falling birth rate. In the UK, the unemployment rate remained unchanged at 3.7% in the three months to the end of November. Earnings climbed at the strongest pace in a decade, rising by 6.4% – of course once inflation is taken into account wages fell by 2.6%. Private sector wage growth, at 7.2% was well ahead of public sector wages at 3.3%. Hence the 467,000 working days lost to industrial action during November. UK inflation eased to 10.5% in December, down from 10.7% in November and 11.1% in October. Core CPI, which excludes food and energy was unchanged at 6.3%. Inflation was driven by food prices, up 16.9% year on year, as well as higher hotel, travel, and café/restaurant prices. On the other side, falling petrol and diesel costs helped bring the overall number down slightly. Bank of England Governor Andrew Bailey started the week that while inflation was easing, there is a risk it will not fall as fast as expected but sounded more upbeat when speaking yesterday, describing recent inflation data as “the beginning of a sign that a corner has been turned”.
Our monthly asset allocation meeting took place this week and we remain underweight in equities and slightly overweight in bonds. We remain active in changing the size of our underweight on a tactical view – equity markets have recently displayed some short-term momentum for various reasons, including falling energy prices which has helped sentiment particularly in Europe. The pace of worsening in the economic data has slowed and this has led some investors to conclude that the expected recession later this year may not be as deep as feared. We have to remember though that we are yet to see the impact on economic activity of the central bank rate hikes – as a rule it takes between 12-18 months for rate hikes to show in the economic data and with hikes only starting last March in the US, and July in the eurozone, the ‘hangover’ is yet to kick in. So, we are in a period where economic data is ‘less bad’ than feared, inflation is easing leading to hopes for central banks not having to raise rates much further and the economic impact of the rate hikes is yet to kick in. Is this the calm before the storm? Quite possibly, but it does mean that equity markets may have some short-term respite before the impact of the rate hikes begins to take its toll on economic data. We still see more difficulties ahead, but times like these call for pragmatism and a recognition that with recession likely to be a second half of the year event, these markets call for taking both short term tactical and longer-term strategic views.
