Monday digest
Posted 18 September 2023
Overview: Central bank hawks still determined to defang inflation
This time last week, it still seemed as if European Central Bank (ECB) policymakers would hold off on another rate hike, following some dire economic data. But on Thursday, the ECB raised its deposit rate once again by 0.25% to an all-time high of 4%. Markets took the somewhat unexpected news in their stride, with only the yields on short-dated money market paper increasing. The tone adopted by ECB President Christine Lagarde reinforced investor sentiment that this begins a period of rate stability that would last for a few months before rates come down again after next spring. Indeed, euro-denominated bond yields fell with increased pessimism about the domestic economy.
Across the pond, US retail sales and inflation showed more strength than expected. Generally, US actual activity data has exceeded expectations for a few weeks as opposed to sentiment data which has been more mixed. And China’s credit growth data (which we discuss in the second article below) has shown a glimmer of light, as did retail sales and industrial production, perhaps the sign of another economic bounce after the myriad of policy announcements.
As we head towards the end of the third quarter, US earnings expectations for next year continue to push higher, which is leading to a relatively broad sense of optimism. It has also been notable that stocks with good earnings expectations momentum have recently turned to being the leading performers rather than ‘thematic’ stocks like those associated with artificial intelligence. In general, institutional investors feel a lot more comfortable when earnings are what is causing equity price rises. Overall, it’s noticeable across the board that volatility and associated risk has continued to edge lower, perhaps signalling a period of steady calm. The strength of the Arm Holdings NASDAQ debut (which climbed 25% after the IPO priced it at $51 per share) has helped as well. The positivity seemed enough to offset another week of oil price rises.
Europe and the UK face some stiff headwinds compared to the Americas and Asia at the moment, and that is feeding through, particularly into the currencies. Both the GBP and the EUR have slid another notch against the USD and, reversing the trend of the previous weeks, are now weakening relative to RMB and stable against the JPY. Without the prospect of near-term fiscal or monetary policy action, this may continue for some time.
The ECB plays its hand, but what will the Bank of England do?
We await the Bank of England’s (BoE) rate decision on Thursday, and many investors are wondering whether it will pause its rate hiking cycle after 14 consecutive hikes. Less-than-encouraging data releases last week have only heightened the tension. The UK’s gross domestic product (GDP) shrank by 0.5% in July, as the double impact of a soggy month and industrial strikes took a toll on growth. Perhaps the ECB’s deliberations after poor data releases offer us a clue to the BoE’s thinking. Catherine Mann, one of the external members of its Monetary Policy Committee (MPC), has already signalled her vote for another rate rise, although other committee members seem more reluctant.
The August survey from the Royal Institute of Chartered Surveyors (RICS) suggested housing sentiment has become notably darker following some mid-summer lightness. They see little house-selling activity and expect prices to go lower in the coming months. This echoed Nationwide’s House Price Index for August, which showed a drop of 0.8% from July. Often, a weaker housing market feeds into the wider economy and lowers inflationary pressures. But we are not really seeing this at the moment. Transaction volumes have been low, and landlords are opting to pass on higher costs (interest rates and possibly energy and maintenance) to their tenants.
The UK’s situation feels oddly similar to the recent problems in China. Xi Jinping chose to deal with the problem of affordability which has had a substantial impact on the domestic economy. Our government has to grapple with the impact on affordability of long-term housing undersupply for both buyers and renters. Elevated tenant demand relative to supply allows landlords to keep rents high or increase them – and that is occurring during this period of change. Meanwhile, the average cost of a house is now about 7.5 times the average annual wage (our calculation from the Nationwide data and Office for National Statistics data), down from 8.5 one year ago. It still has a long way to go before we get close to the pre-2000 level of below 5 times, when interest rates were at similar levels. Either wages will have to keep rising at a reasonable clip for a long time (which comes with inflationary tendencies) or house prices have to fall further, or both.
Chinese growth: no bazooka but lots of bullets
Following its reopening late last year, Beijing has kept up a steady stream of policy supports coming to the sluggish Chinese economy. But these have not been enough to persuade investors of Chinese prospects – least of all foreign investors. Much of the market commentary has focused on whether Beijing will use its ‘bazooka’, a reference to full-throttle stimulus used in previous difficult periods like 2008 and 2015. There is little indication that the government will fire its big gun, but the received view is that investors will not be tempted back unless they do. The short-term growth forces are gathering in China and, with foreign investors already having dumped so much of their stock of Chinese assets (short Chinese equity has become a crowded trade), this is an ‘easier’ base from which to get a rebound in stock prices. The big question for western investors, though, is what all this means for the long term, and whether a longer-term reassessment of how China fits into the global economic and financial picture may be necessary.
The so-called ‘Japanification’ of China – long-term stagnation fuelled by aging demographics and historic asset bubbles – is an increasingly popular narrative, and renowned economist Mohamed El-Erian opined last week that China might not become the world’s largest economy after all. Some commentators have even suggested not stagnation but acute crisis, thanks to a property-inspired financial implosion. We suspect that might be overly pessimistic. While we see the ‘Japanification’ narrative as a little oversimplified, it is fair to say that China’s assets have become much more difficult to call beyond a certain timeframe, predominantly as domestic and international policies have become more influential. Short-term bounces are possible, but we expect the unenthusiastic attitude displayed among foreign investors will continue.