Monday digest

Posted 16 January 2023

Overview: Football fever helps stave off UK recession
The new year is proving to be a happy one for almost all asset classes and regions. Here in the UK, the FTSE 100 closed on Friday at 7,844 less than 60 points from its all-time high. The global financial press tells us markets are stronger because of fresh optimism of a likely easing in monetary policy because – as business leaders say – conditions are awful. And yet things are not that awful. On Friday, the Office for National Statistics (ONS) reported that UK gross domestic product (GDP) unexpectedly rose 0.1% in November. According to the ONS, the Qatar World Cup marginally helped consumer-facing businesses and the impact of strikes was not that severe. Unless December’s GDP figure falls more than 0.4%, the UK economy should avoid a technical recession in Q4 2022.

The Bank of England (BoE) had anticipated a recession was already underway in 2022’s second half, although its monetary policy views are more concerned with supply-side weakness, a problem it sees lasting into 2024. On Friday morning, Monetary Policy Committee (MPC) member Catherine Mann suggested the surveys showing still above-target UK household and business inflation expectations would mean larger rate rises were still on the cards. The European Central Bank (ECB) also seems firm in pushing ahead with rate rises, to the point of actively constraining economic activity. Even though it is lower than elsewhere, European core inflation is at its highest-ever level, and policymakers are still very worried about inflationary dynamics. Lagarde says these “are mainly related to fiscal measures and wage dynamics,” and the ECB still needs to tighten hard to counteract them.

Across the pond, members of the US Federal Open Markets Committee (the equivalent to the UK’s MPC) were also vocal that rates are still going up, although US bond investors believe the rate rises are nearly done. The slowing of wage rises is also apparent, as the average hourly earnings data showed in last week’s nonfarm payrolls. At the same time, few investors appear to believe a US recession is about to take hold. The bond market also tells us that fears of defaults in the credit market are declining – a stronger indicator of recession fear than the yield curve inversion.

Fears that the world was close some sort of economic precipice seem to have dwindled significantly. Investors may already be discounting a rosier picture, one where the nasty risks of 2022 seem to have ebbed quickly away. But the central bankers may need some convincing that a wage-price spiral is no longer a danger, given that as yet there is only the mildest of hints that the pressure has eased. We’ve had two weeks of ‘bad news is good news’ helping the markets. For markets to go higher in the long-term, let’s hope we have a run of ‘good news is good news’.

Commodities set to run hot once again
Last year was a strange one for commodity markets. Russia’s invasion of Ukraine wrought the biggest disruption to global energy supplies in a generation, causing oil and gas prices to soar over the first half of 2022. Sharply higher prices then destroyed demand and severely dampened the outlook for global growth. Oil and gas had a much weaker second half, as supply chains re-adjusted and demand fell significantly. Even European gas prices, which rose to eye-watering levels after President Putin turned off the tap, are substantially lower than their mid-year peak. Policymakers, analysts and capital markets predicted a harsh winter for Europe, with heat and energy rationing amid acute undersupply. However, this winter is predicted to be one of continent’s warmest on record, taking the edge off fuel prices. 

This would appear to dampen the commodity outlook, but demand from China could reverse this dramatically. Beijing has now suddenly pivoted to an extremely pro-growth policy mix. The zero-Covid policy is ending, restrictions on the property sector are vanishing, and the People’s Bank of China is actively loosening monetary policy. There is likely to be a splurge of infrastructure building as we go through 2023, which will spark massive demand for raw materials. This is about as big a boost as the government could possible muster – making China’s domestic economy look like a coiled spring – and significantly improves the outlook for global commodities.

Chinese assets have rallied in the new year, and markets appear to be significantly frontrunning demand. Given Covid is still hampering activity, it could be some time before actual demand comes through. And given how much positivity is priced in, markets could be disappointed by Chinese growth. That said, China’s post-Covid bounce could well be even stronger than the one experienced in the western world. More than 1.4 billion people have been under some form of restrictions for more than three years, suppressing a great deal of their regular economic activity. There is a massive amount of pent-up consumer demand waiting to be released. On top of this, the Chinese government is easing other key policy areas like construction and finance. Not only will people want to go out and spend, but businesses will be eager to undertake projects put on hold for years – and they will have the capital needed to do so.

It is true, however, that we may have to wait before such strong demand comes through. Covid infections are extremely high and, even without government restrictions, this will inevitably hamper movement until cases come down. The Lunar New Year festival in February – usually a very active period – will likely be significantly busier than last year, but the virus will probably keep activity at relatively subdued levels , and it might not be until warmer weather comes in March that we see the turnaround become meaningful.

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