One of the aftereffects of Covid is high inflation almost everywhere in developed markets. Some of this inflation is temporary bottle necks, but more sustained price pressures have emerged in the job market. While the US is leading the pack, the economic recovery is visible across developed markets. Even as inflation surges, consumers could fund several years of strong consumer spending growth from savings built up during the Covid crisis. Companies are also spending, including increased investment. And it’s not just developed economies, the economic recovery is also visible in emerging economies. Focusing on the US, interest rates look too low, far too low in my view. Indeed, if the Fed does not increase the pace of tightening the risk of recession in 2023 will rise. Like driving a car towards a bend in the road, failing to ease off the accelerator in good time can risk having to slam on the brakes, swerving the car into a recessionary ditch!
Growth and inflation
- Reported case fatality rate (CFR) is 4.5 bps compared with 5-10bps for ‘flu. Adjusted for ‘dying with’ rather than ‘dying from’ Covid, CFR falls further (by 40% says a
- University of Copenhagen study). Antivirals cut the number further – by 80%.
- The best guess is that new variants from now on will be more transmissible but less severe, and we almost certainly won’t see anything like the same lockdowns which we suffered in 2020.
- This suggests that the impact of covid on economic is disappearing.
Wages are rising rapidly in the US
Source: Columbia Threadneedle Investments and Atlanta Federal Reserve as at 17-Feb-22
- One of the aftereffects of Covid is high inflation almost everywhere in developed markets, with Japan a notable exception.
- Some of this inflation is clearly temporary bottle necks, but as these ease more sustained price pressures have emerged.
- Wage inflation has recently exploded. The graph shows a data series that is very influential with the Fed, so I include it every month in my webinar.
In aggregate UK consumers have built up huge excess savings
Source: Columbia Threadneedle Investments and Bloomberg as at 08-Feb-22
- With consumers and companies both well stocked with cash and the economy recovering, the rise of inflation has done little to dissuade them from spending.
- Consumers have accumulated huge spending power from the massive fiscal packages and the restrictions which meant they couldn’t spend in the normal way. Even if only part of this Covid piggy bank is drawn down over the next couple of years, consumer spending would be strong.
- Despite the shift in expectations, interest rates in the short and long term remain below inflation.
UK public finances are improving rapidly
Source: Columbia Threadneedle Investments and Bloomberg as at 18-Feb-22
- Consensus expectations for the UK budget balance show a big improvement and one that should continue. On present plans it’s even possible that the UK government balance the books.
- This reflects not just the economic recovery but also the ‘hidden’ benefits to the budget from inflation and fiscal drag.
- This should help cool the economy and also repair the damage to government finances from Covid. But relying on politicians to do the unpopular work of slowing the economy seems unwise.
- If governments spend rather than save their windfalls, then the burden shifts to central bankers to raise interest rates even further and faster.
What does this all mean for markets?
- Market expectation for interest rate rises may have moved a long way, but not far enough. The economic recovery has built up a head of steam, so central banks must raise rates and the sooner the better if they are to avoid an inflationary boom/bust.
- This is a tough background for equities, but I am still optimistic in the longer term. I am more positive on emerging markets and for value over growth style on the back of economic recovery.
- I am much more bearish about bond yields, which are likely to out-perform only if we get a recession, which looks most unlikely to be a factor until 2023 at the earliest.
