Multi-Manager People’s Perspectives

Before I recap recent events, a reminder of our 2023 outlook which you can read here, and to watch the replay of our webinar from last week if you’ve not yet done so.

It’s been quite a while since the last weekly update –  just before the FIFA World Cup final – which now feels like a very distant memory (well done Argentina by the way.) Thankfully, financial markets were very quiet over Christmas despite a slight curveball from the Bank of Japan. We have seen investors continue to be reminded by the central banks, in particular the US Federal Reserve, that the fight with inflation is not over, despite inflation appearing to have peaked. European markets have rallied thanks to lower- than-expected inflation data, though a key theme for 2023 looks to be the ‘peak inflation’ versus ‘persistent inflation’ narrative.

We saw a rare event before Christmas – an exciting Bank of Japan meeting (!). While interest rates were left unchanged and remain negative, the Bank announced it would allow the Japanese Government Bond (JGB) yield to move within a wider range, to a limit of 0.5%. The JGB yield has looked more and more of an outlier as other government bond yields have risen over the past 12 months. And, maintaining the yield at such a low level involved a huge amount of bond buying ($128 billion in December alone) which was clearly not sustainable. The move was seen as a precursor to more significant changes in Bank of Japan policy, most likely later this year when Governor Kuroda is replaced. It removes one of the last anchors to the ultra-low borrowing costs that have formed the backdrop to financial markets for the last decade.

The Federal Reserve minutes from the December meeting emphasised rates were not going lower; “no participants anticipated that it would be appropriate to reduce the target rate in 2023”. In a speech, Fed Chair Jay Powell noted that raising interest rates will cause pain – a nod to the inevitable political pressure that will come when the US economy weakens and people start losing their jobs. He said “restoring price stability when inflation is high can require measures that are not popular in the short term”.

Powell’s colleagues have continued to emphasise the Fed is not likely to reach peak rates and immediately begin to loosen policy; a hope that financial markets are hanging on to. Raphael Bostic of the Atlanta Federal Reserve summed it up when he said he saw the Fed as committed to hiking “into a 5-5.25% range and then holding there through 2024 to stamp down on excess demand in the economy”. Bostic’s comments on the duration of rates staying high and the implication that cuts are not imminent echo the tone of the Fed’s December meeting which noted a concern that a “pause” in hiking rates could be mistaken as a “pivot” towards lower rates.

The World Bank made a significant downgrade to its growth forecast for 2023, with the majority of the weakness expected in developed markets. In cutting their global growth forecast to 1.7%, from a forecast of 3% last June, the Bank described the global economy as “perilously close to falling into recession”. Bank President David Malpass said they anticipated a “sharp, long-lasting slowdown” which would be “broad based” leaving the growth in household earnings, in almost every country, likely to be “slower than it was in the decade before Covid-19”.

The Bank expects developed market growth of just 0.5% in 2023, with emerging markets growing by 3.4%. The head of the International Monetary Fund, Kristalina Georgieva, told US media they expect “one third of the world economy to be in recession”, with a tough year ahead as the US, eurozone and China slow simultaneously. Georgieva noted that “even for countries that are not in recession, it will feel like recession for hundreds of millions of people”. Happy New Year indeed.

Much of the growth in emerging markets will depend on China and since the last update we have seen some dramatic developments there. The zero Covid era has come to a swift end with restrictions removed and testing structures dismantled. The speed of the removal of restrictions has been something of a surprise, given the scale and scope of the measures, that were in place for the best part of 1000 days, and the political capital and pride taken in China from seeing Covid cases and fatalities far lower than the rest of the world.

The removal of restrictions means China is now in the midst of a huge ‘exit wave’ as the Omicron variant sweeps through the population with estimates of 3-5 million new cases a day – in the absence of testing accurate numbers are hard to come by. This is resulting in significant stresses on the healthcare system, not least given that the poor vaccination rates amongst elderly age groups had yet to be addressed. Short term economic disruption is also inevitable but looking forwards, we do see an economic boost from several years of pent-up demand, not least in the travel and leisure sectors.

Despite some countries imposing travel restrictions on visitors from China, the positive news for the rest of the world is that despite huge daily case numbers, we have not seen any variants of concern recorded so far. China will likely see several waves of the virus, particularly as a result of travel and social mixing during Chinese New Year at the end of this month. But the template for China is the experience of the rest of the world, where we are at the ‘endemic’ stage of the virus.

In politics, we saw what appeared to be a peaceful transition in power in Brazil with President Lula da Silva sworn in on 1 January. However, last weekend the city of Brasilia saw scenes reminiscent of the attack on the US Capitol building in Washington 2 years ago, with protestors storming the Congress building, Supreme Court and Presidential Palace. The violent protests resulted in a huge number of arrests and condemnation from all sides, including from outgoing President Bolsonaro, who had been surprisingly quiet since his election defeat, not least given his comments before the election regarding corrupt voting practices and his promise that “only God can remove me from power”.

President Lula blamed Bolsonaro for “encouraging” the mob and for leaving the country in “terrible ruins.” In the coming weeks Bolsonaro is expected to return to Brazil from his self-imposed exile in Florida, and quite possibly into some legal trouble. The episode serves to remind us that in Brazil, the US and elsewhere, politics in this social media driven era is more divisive than ever. This poses longer term implications for democracy as the shift from traditional news reporting to an environment where individuals are in a social media ‘echo chamber,’ continues to have destabilising consequences.

In the US, Kevin McCarthy managed to – after 14 unsuccessful votes – secure a majority to approve him as House Speaker. US politics faces a divisive run in to the next election with Republicans promising more oversight of President Biden, some big battles to come on budgets, and the potential prosecution of President Trump over his role in the 6 January 2021 insurrection. Also, expect a lot of noise around the ‘debt ceiling’ which needs to be increased once again this year.

Looking at economic data, inflation has continued to ease across developed markets, though it remains at levels that gives central bankers sleepless nights. The signs of inflation having peaked have certainly helped sentiment though. Eurozone inflation for December was 9.2%, lower than the expected 9.5% and down from a peak of 10.6% in October. In the US, December’s pace of inflation slowed for a sixth consecutive month, coming in at 6.5% year on year, in line with expectations.   

The US PMI and ISM data was interesting in that while the eurozone data remained in ‘contraction’ territory, the European data for December was ‘less bad’ than November, highlighting the positive impact that the 50% drop in gas prices is having on regional sentiment. Despite a cold snap in December, overall European temperatures have been well above average so far this winter and gas supplies are plentiful. Europe has storage capacity for 25% of annual requirements and reserves remain around 80% full – a very high level for the second week of January.

For comparison, the UK only has enough storage for 1% of annual requirements – maybe we need a comeback for all those gasometers that used to be on the edge of every town and city. The key message from the PMIs is that in the absence of high energy prices, the slowdown in European economic activity has eased. Despite also seeing falling energy prices, the UK failed to mirror the improvement seen in eurozone data.

In the US, the ISM data showed both manufacturing and services in ‘contraction’, with a very sharp drop in the services component. US markets reacted positively to the data – ‘bad news’ is ‘good news’ of course because it means the Fed will ease rates. I’m not sure it’s that simple – particularly given the strength of the US labour market, which posted strong data yet again in December. The unemployment rate at 3.5% was at its lowest level since 1969.

UK GDP data for Q3 2022 was revised lower, to -0.3%; the economy at the end of Q3 was 0.8% smaller than before the pandemic. The UK remains the only G7 economy that is yet to recover. Real incomes fell by 3.1% versus 2021; the Office for National Statistics expects real incomes to fall by 7% overall by Q1 2024.

In terms of our positioning, I refer you to the webinar and outlook mentioned at the start for the detail. In summary, however, we remain cautious but note the tailwind of lower energy prices may mitigate some of the worst-case scenarios for the economic outlook, particularly in the UK and Europe. Let’s hope the colder weather that is in the forecast next week is short lived…