Monday digest
Posted 22 August 2022
Will a new PM be good news for investors?
It’s almost certain Liz Truss will win the Conservative Party leadership contest and become the UK’s next Prime Minister on Monday 5 September. She will face a very difficult start, given the state of the UK economy. The most obvious expression of this is consumer confidence, and the GfK Consumer Confidence Barometer is currently at -44, in other words, very low. One reason is the reduction in the purchasing power of UK disposable incomes. The reining-in of consumer spending is likely to worsen as the weather cools and the next massive change in energy prices falls due. Average bills are expected to top £3,600 a year when the new energy price cap is announced on Friday.
Optimists can make a case that it’s not all bad. The unemployment rate is around 3.8% and jobs are plentiful – even if people may feel hard done by. However, while jobs are being created, the pace of job creation has slowed and the fact that consumers are reducing spending in volume terms is evident in declining real GDP terms as well as in the retail spending data.
For the Bank of England’s Monetary Policy Committee (MPC), another rate rise of at least 0.5% in September seems as certain as Liz Truss’s victory. The market currently prices a rise in base rates to over 3.75% by March 2023. Moreover, the Bank of England will have its remit examined immediately by the new Truss regime, and this might be a source of worry for the currency market. It is unlikely the government would try to challenge the Bank’s independence directly, but currency traders may worry about greater political influence exerted on its decisions and analysis.
At least we are not alone. The rest of Europe has similar concerns over inflation and energy. And while natural gas and electricity prices continue to rise, oil prices have fallen substantially over the past few weeks. Moreover, US growth remains strong, almost uncomfortably so. Investors are moving back to expecting more rate rises from the US Federal Reserve (Fed) but that is in response to solid signs of economic resilience, something which is welcome for a softer Europe and UK. Despite Europe and the UK’s issues, the profit outlook for our global companies has remained positive, especially in Sterling and Euro terms. As we have observed recently, globally-oriented portfolios can still hold up reasonably well even if the outlook domestically is more gloomy.
Biden’s stalled presidency receives a welcome boost
For most of his presidency, Joe Biden’s ambitious fiscal plans have been repeatedly thwarted, both by Republican opposition and by those within his own party. So, it was something of a surprise that the commander-in-chief’s $700 billion climate, health and tax package passed through the frequent buffer to Presidential plans, the US House of Representatives. In an era of increased partisan US politics, this is a notable achievement.
In truth, it is an inflation reduction act in name only. It is designed to increase corporate tax revenue, constrain the pricing power of pharmaceutical companies and increase incentives for green investment. The Act’s environmental provisions will likely have the biggest impact. Americans will be able to take advantage of tax credits to buy electric cars and solar panels for their homes, while the US government will invest heavily in renewable energy production and storage. The Act remarkably also introduces a tax credit for so-called green hydrogen, made via electrolysis of water using renewable energy. This is currently costlier and less popular than standard hydrogen production, which uses fossil fuels and releases large amounts of CO2, but costs are expected to fall over the next decade.
From an investment point of view, the big positive is that the law invests heavily in long-term supply- side changes. Given the acute undersupply in the current global economy, that is welcome news. These will not affect short-term inflation – whatever the name suggests. But they set the tone for greater opportunity ahead. Whether all these measures stay in place in the years to come is uncertain, but the investment it could spur will have a big impact nonetheless.
China’s leaders brace an uncertain few weeks
While the world’s major central banks are aggressively raising rates to fight runaway inflation, the People’s Bank of China (PBoC) surprised us all last week. It delivered a 0.1% cut to the medium-term lending rate, increasing funding to some financial institutions. It also injected CNY 2 billion into the financial system. Even avid watchers of PBoC policy were caught off guard by the move.
China’s monetary policy has diverged from the rest of the world because the key concern is weak domestic demand, from its ailing property sector and sporadic Covid-induced lockdowns. The credit impulse – a measure of how much credit is contributing to overall GDP – has increased in recent months, but not by a huge amount. Alongside falling loan growth, industrial output, investment, retail sales, property sales and construction all showed signs of slowing growth or outright decline. Simply put, following a particularly strong June, July was a disappointingly weak month and appears have been enough to create the policy change.
We should not ignore the other source of consumer disquiet. The zero-Covid policy has repeatedly put swathes of China under damaging lockdowns. Currently over 25% of China’s GDP is at risk of being locked down again (according to Bloomberg Economics’ calculations of 17 August). The policy is harder to change, given it has become ingrained in the way the Party has governed for more than two years.
The 20th National Communist Party Congress will likely be held at the beginning of November and for President Xi’s to affirm his authoritarianism and aggressive foreign policy, he needs a strong and vibrant economy. This is more than just a question of window dressing. Public desire for personal economic growth and common prosperity are used by the Communist Party to maintain power. For now, economic volatility remains an impediment to consumers, growth is probably improving, while policy continues to ease. Xi may still be reluctant to add to this policy change, but he desperately needs to give consumers the boost they crave.