Monday Digest

Posted 13 February 2023

Overview: a challenging week brings investors back down to earth
For most of this year, investors have ran with the notion of a decline in longer-term inflation pressures, but they have been less convinced in recent days. As a result, bond and equity markets slipped back last week, despite the FTSE 100 reaching a new all-time price high on Thursday of 7949.57. What’s caused the sudden downward mood? Arguably January’s exceptionally strong US employment data weakened a key component of the market rally, knocking back while expectations that central banks would soon slip into neutral gear. Last week, Catherine Mann, an independent member of the Bank of England’s Monetary Policy Committee, warned there were still likely more rate rises to come in the UK, while in the US, Federal Open Markets Committee members also suggested that while the pace of rate rises may have slowed, the end was not yet in sight.

For most investors the question now is whether growth this year and next year will be slow but steadyish, or will it be “too strong” and therefore be forced to slow more dramatically by ever-tighter monetary policy. If we want an early path to lower interest rates and an early path to steady profitable growth, perhaps it is preferable to get weaker economic data now. The UK’s 2022 fourth quarter gross domestic product (GDP) data could not be described as strong although, contrary to expectations, it did not show a contraction. The quarter showed no real growth at all, while the mix was a little surprising, with services weaker than expected while manufacturing was stronger.

One of the reasons why markets have rallied this year is that we haven’t had any nasty shock for some time – Russia’s invasion of Ukraine was the last serious one. Markets could therefore plod along, eking out steady but small returns, while firms improve their cost bases amid slowish revenue growth alongside slowish economic growth. As we said at the start, further declines in bond yields and inflation expectations would be a big help.

Lastly, a quick mention on energy prices. There is still a possibility of cold weather for this winter, but gas storage levels remain very high across Europe in comparison to past years. In France, the main gas supplier estimated it will have storage at 40% capacity by winter-end, unless there are extremely freezing conditions substantially above normal. Gas and electricity prices continue to fall for next winter’s contracts and are now only double the price of winter 2021, before Russia removed supply. That still may sound terrible, but a return to near-normality now looks increasingly feasible.

Natural disaster hits Türkiye’s economy too
In the wake of tragedy, discussing the economy can sound a little callous. The earthquake in Türkiye and Syria has killed more than 35,000 people, and injured tens of thousands more. The scale of the devastation is not yet clear, but the real toll will likely be much higher, with hundreds of thousands displaced from their homes. Over the longer term, rebuilding efforts will require resources and investment, which will mean smaller capacity for other things. In short, economic impacts are human impacts too. These impacts could be amplified by the nation’s already weak economy. President Erdogan has already pledged $5.3 billion in emergency aid. Given the government is running a budget deficit, short-term funding will mean extra borrowing. This will likely come at a great cost; yields on 10-year Turkish bonds are at 11% right now, and could go higher if more cash is needed.

Unfortunately, the global financial system does not stop to mourn. In the wake of the disaster, international investors sold Türkiye’s Bist 100 index at a rapid pace, culminating in a 7% fall on Wednesday morning. The negativity caused stock trading to be suspended, and reflected deep concerns over the hit to Türkiye’s productive capacity. However, while the stock market is closed temporarily, other indicators are not currently suggesting volatility in Turkish assets. Spreads on Turkish bonds (the difference between US and Türkiye yields) have barely moved, while the lira has remained static against the dollar in the days since the crisis. Perhaps this is testament to the support that Türkiye now has in the international community. President Erdoğan’s clashes with international markets are well documented, and have led to an inflation crisis in Turkiye which long predates global supply-side problems. But natural disasters can generate a lot of support for the afflicted countries – both politically and financially in the form of aid. If there is any good to come from this at all, it will be that President Erdoğan improves his relationship with western leaders. Regardless of his own politics, that will vastly improve the country’s prospects of rebuilding. The people of Türkiye desperately need that help now.

Will world trade die with the WTO?
When it launched in 1994, the World Trade Organisation (WTO) was the crowning achievement of western neoliberalism: an international regulator dedicated to lowering trade barriers around the world, opening up economies and creating a genuinely global market for goods, labour and services. But WTO members have not made any progress on new rules or treaties for more than two decades, and its court of appeal has not had the required number of judges – meaning disputes cannot be settled and its existing trade rules are unenforceable. Unless the court is rejuvenated, the world’s WTO trade laws will just be scraps of paper.

The question is, then, will world trade wither and die with the WTO? More likely is an increased reliance on regional trading blocs or supply chains. Within these regional blocs, trade links are likely to become deeper, even if the links between regions become shallower. This process is already playing out in Asia, Africa and South America. There is a good chance it could lead to a renewed bout of European integration too, particularly if European leaders think the US is no longer a dependable trade partner.

The latest White House policies suggest President Biden plans to take full advantage of a world with fewer trade rules. The Inflation Reduction Act (IRA) passed in August promised tax breaks or subsidies for clean energy companies, with support tied to energy being produced in the US. European politicians are reportedly furious with flagrant attempts to give US companies a competitive advantage. But with the WTO crippled, they effectively have no recourse. The impasse seems to be making European Union (EU) lawmakers question their own trade rules. Currently, these restrict subsidies and state investment to encourage greater competition. But last month, European Commission president Ursula von der Leyen told delegates in Davos that the EU “needs to be competitive with offers and incentives that are currently available outside the European Union”. If they follow through, it would likely mean a chain reaction where nations around the world put up higher and higher trade barriers in reaction to one another. Therefore, a moribund WTO could have lasting and wide-reaching consequences.