Munix Weekly 13 May 2022
A fork in the road
This year has witnessed bond yields move steadily higher, recently reaching some Big Round Numbers, namely 1% for Germany, 2% for UK gilts, and 3% for benchmark US Treasury 10 year yields. This week saw a reaction, however, for example the UK benchmark yield has fallen back to 1.75%. In essence one rate increase has been taken out of the timeline for future monetary tightening. There is a myriad of reasons but in essence investors see a fork in the road ahead – a debate is building about whether the prospects for Western economies are a world of stagflation or the prospect of actual recession.
‘Stagflation’ was first described back in the 1960s and popularised in the 1970s – a deeply unpleasant mixture of both stagnant growth and painful, double digit inflation. The latest data from UK sadly suggests that a pale imitation of this is being seen.
Inflation is certainly much higher in central banks would like to see, and looks to be higher for longer as well. US headline consumer inflation did edge down to 8.3% year on year in April, but the details showed the sticky nature of such important areas as housing or medical care. Next week’s UK CPI is expected to show annual inflation jumping again to reach 9-10% from a year ago as the surge in energy costs took effect. Market surveys suggest only a slow deceleration in most countries into 2023. The latest news about higher gas prices, as Russia, Ukraine and Europe argue about obstacles to gas shipments, does not help.
Although the UK economy grew by 0.8% in Q1, this was driven by a rebound in the first two months whilst there was a small decline in March. Surveys of high street spending show weakness in Q2. The Bank of England’s quarterly forecasts are not necessarily pinpoint accurate, but they do suggest GDP oscillates between modest expansion and contraction well into 2023. The National Institute of Economic and Social Research caught the headlines with its firm forecast that the UK will experience a modest recession in the second half of the year.
The UK faces major headwinds from the Chancellor’s tax hikes. Nevertheless, growth forecasts are being lowered in many countries. China’s covid lockdowns are beginning to affect global supply chains once again. Indeed the period of steadily falling unemployment in America and Europe seems to have come to an end. The good news is that there are few signs that banks are restricting access to credit, which normally makes a bad situation worse.
Such growth worries help explain why share prices and crypto currency assets have suffered a lot of pain in May. The global stock market is down about 20% year to date with previouslyexpensive areas such as Nasdaq stocks closer to 30%. It is no surprise that risk averse investors are selling up to hold cash or safer bonds.
Central banks undoubtedly will raise interest rates in coming months to ensure that inflation expectations remain under control. For example, Christine Lagarde has made it very clear that the ECB will make its first 0.25% rate move in July, with markets pricing in two more later this year. The Fed is on course to move at every meeting for the rest of this year. The UK is beginning to look more of an exception. Although bond markets see a peak in rates at about 2%, a number of economists are suggesting that the Bank might only move in June and August before then pausing while it assesses how the growth slowdown affects the labour market and wage pressures.
What is the probability of a deep recession in 2022 or 2023? Most surveys of economists suggest that it is only a 1 in 4 or a 1 in 3 probability. Even the UK should see flat to modest growth over 2022 and 2023 as a whole. However, the main problem for central bankers and economists is considerable uncertainty about so many factors. How will the war affect future energy supplies? How long will the lockdowns occur in China and what does this mean for global trade? What is the ability of Ukraine to export food through Europe to Africa and the Middle East? These are only some of the key questions which need to be considered before it is clearer which fork in the road the global economy will take.
Bond yields at the time of writing this week and one month change
% 2 year 5 year 10 year
USA 2.62 (+0.25) 2.89 (+0.23) 2.90(+0.21)
UK 1.24 (-0.24) 1.38 (-0.18) 1.75 (-0.07)
Germany 0.11 (+0.02) 0.61 (+0.04) 0.95 (+0.17)
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making