Monday digest
Posted 15 May 2023
Overview: Trust the MPC to rain on May’s parade
After a period of waiting, things are hotting up after central banks acted as expected. Although equity and bond markets have been bearing up well, in our estimation, underlying risks have increased since May began. Last week, it was the turn of the Bank of England (BoE) to increase the UK base rate to 4.5%. After members of the Monetary Policy Committee (MPC) digested reports of tepid growth of 0.1% for Q1 (with March contracting by 0.3%), the 0.25% hike was nailed on. The BoE raised its estimate for economic activity this year and no longer thinks there will be a recession. However, year-on-year inflation is now likely to take longer to ease off, and is expected to remain above 8% as of June, and to finish 2023 at 5.1%. It says the risks are skewed towards inflation staying well above its 2% target. Not everyone agrees. The BoE still worries the UK does not have enough resources to fuel overall growth which is why it sees inflation risks skewed to the upside. The biggest resource shortage is the number of workers (skilled and unskilled) needed to do the work, and it’s difficult to see how this will be resolved in the short to medium term.
Meanwhile, the environment for businesses across the developed world remains difficult. Rises in short-term rates have happened almost everywhere and at the same time. Indeed, apart from the early 1980s, there has never been a such a period with virtually all central banks acting as if in concert. That unified action also means their policies have an unprecedented global impact, magnified by a more interlinked world than in the 1980s. At Tatton, we’re sure central bankers take into account the impact of each other’s decisions, and yet this final phase of rate rises could be viewed as coordinated overkill.
US debt ceiling brinkmanship is nothing new
US Treasury Secretary Janet Yellen has warned the federal government could default on its debt obligations very soon. Perhaps the oddest thing about this state of affairs is that it doesn’t feel like big news. The Treasury hit the current debt ceiling – at $31.4 trillion – on 19 January. Since then, it has been steadily running down the ample funds in the Treasury General Account, buffered by April’s tax receipts. President Biden wants to “take the threat of default off the table”, but Republican House speaker Kevin McCarthy has said his party’s position remains unchanged. Estimates for when the X-date (when the US is officially unable to meet its obligations) falls due are varied, with the latest suggesting it could come in August. But Yellen has warned the government might be unable to meet all its obligations as early as 1 June.
While the media gets excited about the debt ceiling soap opera, we’ve all been here before (at least three times since 2011, to be exact). And realistically the US government’s default risk is zero. Moreover, behind all the brinkmanship, US lawmakers will not want to bankrupt the government. Nevertheless, Biden’s suggested invoking of the 14th Amendment – which states the viability of US Treasury bonds cannot be placed into question – is a signal of how seriously he takes the situation. We mostly agree that reaching the dreaded X-date without an agreement is extremely unlikely but would point out brinkmanship can push things over the edge even when all participants do not mean it to. More important is what happens between now and the X-date – particularly for federal employees. The issue will likely see a short-term resolution, but that sets up an interesting budget confrontation later in the year. As well as dictating actual federal spending, that could well set the agenda for next year’s presidential election.
European energy prices: the great reset?
Wholesale gas prices – the main determinant of energy costs for European households and businesses – have not been this cheap since July 2021, when Russia began constricting supply in the lead-up to its invasion of Ukraine. Softer global economic activity appears to be a reason for commodity weakness this year – not just in gas but oil too. Brent crude prices are currently at around $75 per barrel, down from a peak of over $110 last summer.
The removal of Covid restrictions has led to an economic rebound in China and previous Chinese growth spurts coincided with substantial commodity price rises. So why has this not happened so far this year, despite definitely positive growth in the world’s second largest economy? Recent import data from China shows a decline in the value of oil and gas imports. Interestingly though, the volumes of oil being imported are still very high – just cheap. Indeed, the implication is that the prices are well below market. This is almost certainly because China is soaking up cheap oil on offer from Russia, which has ample supply but few willing customers in the west. We suspected this was going on for some time, and the latest data effectively confirms it. Global energy distribution has reset; the higher prices of 2022 have encouraged new sources of supply. The Russian reduction of energy supply to the world as a whole has proved temporary.
While few will be pleased that Russia is finding buyers for its gas and oil, it probably means that Europe’s peak of the energy crisis – the worst in the post-war era – is now past. After Russia began its war in Ukraine, we said global energy markets would drastically restructure, but without necessarily altering the fundamental balance of supply and demand. We are arguably seeing the results of this restructuring now. If so, it would mean downward price pressure is reaching an end. Europe’s energy crisis has certainly improved, but the continent might still have a tough winter ahead.