Monday digest
Posted 16 October 2023
Overview: Capital markets and war
The world took a turn for the worse last week, from a humanitarian point of view. The surprise element of the attack together with the current global economic backdrop, drew immediate parallels with the Yom Kippur War of October 1973, and the oil crisis that followed. Of course, the movements of capital markets are of trivial importance compared to the loss of life and immense human suffering brought upon the civilian populations of Israel and Gaza. However, our job at Tatton is to monitor and interpret the movements and motivations of capital markets and investors, and this remained our focus last week.
Indeed, capital markets are not considered good predictors of changes to the geopolitical risk framework. At the beginning of last week, the oil price rallied predictably by around 4% before falling back towards the end of the week and the move felt somewhat irrelevant following the previous week’s 12% fall. Perhaps this was not overly surprising after all, given the unfolding tragedy seemed to remain confined to Israel and Gaza, rather than spreading to a conflict with Iran via Hezbollah and other Arab states. This may have been a contributor to the stability and even upwards trend in equity markets during most of the week.
At a time when up-trending bond yields make the usual ‘safe haven’ assets of US bonds more at risk to capital losses, the US mega-cap stocks rose as some investors appeared to prefer them to government bonds. Still, benchmark US 10-year government bond yields fell back as well on increased demand, at one stage almost to 4.5%, before pushing back up. This came after after September’s US inflation numbers on Thursday came out higher than expected, suggestion a slowing of the recent downward inflation trend.
So, despite a paradigm-shifting week in geopolitical terms, capital markets appeared as if they had returned to being driven by the same drivers that we have been discussing over the past weeks. However, it would be wrong to conclude that markets are telling us that risks will remain contained. The coming days will be crucial in this respect. For the time being, our thoughts and prayers go out to all that have been affected by the violence and counter-violence, while we also observe that despite the parallels to 1973, oil reserves and regionality of sources 50 years later are on a much more diversified and far more stable footing.
Is the Bank of England actually winning against inflation?
Britain’s inflation outlook is back in the spotlight (if it ever left). The International Monetary Fund (IMF) published a gloomy UK inflation report in which it forecasts prices will jump 7.7% year-on-year in 2023, and 3.7% in 2024. That is the highest predicted inflation rate of any G7 country, and it could mean another interest rate rise from the Bank of England (BoE), with UK rates staying well above peers to the end of this decade. This is despite the IMF downgrading Britain’s growth forecast to just 0.6% in 2024 – the lowest of any developed nation.
In truth, there are some reasons to doubt the IMF’s outlook. UK inflation has proven particularly persistent – compared to both other countries and our own history – but there has been a noticeable easing of price pressures in recent months. Headline consumer price index (CPI) inflation has been trending downwards since February, with the latest print of 6.7% in August. This is likely to come down further when September’s figures are released, thanks to the food price spike tailing off and increased supermarket competition.
Of course, as the BoE has repeatedly emphasised, its policymakers are worried about the tightness of the UK labour market and continuation of a wage-price spiral – one of the factors that pushed core inflation up again this year. Things remain tight, but analysts expect the labour market to loosen significantly in the next few months, moving even below balance. Given that keeping a lid on wages is the BoE’s proclaimed goal in its inflation fight, this should mean the BoE has delivered its last rate rise of this cycle. If the BoE leaves rates unchanged at its November meeting, that would mean two consecutive months of rates on hold and, if inflation comes down again in the meantime, as widely expected, it will send a strong message that the UK’s rate-hiking cycle is over.
Argentina back in crisis?
Argentina is suffering again, with political drama playing out against a backdrop of economic woes. Argentina has elections on 22 October, and markets are bracing for the possible win of radical far-right candidate Javier Milei. Milei, an economist who adheres to anarcho-capitalism, wants to dollarise the country if elected. His strong polling has led many to fear that their pesos could soon become worthless, thereby prompting a run on the currency. With an official exchange peg of 365 pesos per dollar in place since August, most Argentines have to convert savings at black market trading venues. Exchange rates there were reported at over 1,000 pesos per dollar last Tuesday – the largest gap between official and unofficial rates on record.
To heighten the tension, Argentina appears to be ‘robbing Peter to pay Paul’ but with the IMF and China. Argentina owes the IMF $43.4 billion, which accounts for 30% of all the credit extended by the IMF, more than all the countries in sub-Saharan Africa combined. And while IMF officials are aware of the need to cut the cord on Argentina’s struggling economy, the idea of it aligning with China is currently too scary to countenance. In June, the People’s Bank of China gave Buenos Aires an $18 billion swap line, which it immediately used to repay debts to the IMF. This move has never happened in the 80-year history of the IMF. The significance of the event was clearly not lost on IMF officials or US politicians. Just two months later, it gave Argentina another $7.5 billion, despite it not meeting any payment conditions. Only last week, President Fernandez was in Beijing asking for more money, while Argentina has been asked to join the BRICS group, which includes China and Russia.
Those international relationships are now central to the presidential election campaign. Both Milei and centre-right candidate Patricia Bullrich have come out against BRICS membership, with Milei saying he would cut diplomatic ties with China altogether. Both promise pro-market reforms too, with Milei promising to “chainsaw” public spending. Paradoxically, the victory of an anti-China candidate could mean a harsher stance from the IMF toward Argentina, since it would effectively remove the threat of a breakaway. But the flipside is that more restrained spending would inevitably make the IMF happier.
Whatever the case, the outlook for Argentina is not good in the near term. Either free marketeers get their way, and short-term pain comes for (hopefully) longer-term stability, or profligate governments continue to dip in and out of debt crises – sustained only by a lingering geopolitical threat of separation. EM stereotypes are often exaggerated, but Argentina might still be the most deserving of them.