MUNIX COMMENTARY – 14th October
‘Steady as she goes, helmsman’
The boat is heading towards its destination, with a following wind catching the sails and propelling the craft ever faster. Investors in the UK money markets are actively considering that there will be an interest rate hike of 0.25% by year end and similar in Q1.The latest economic statistics and official comments certainly explain their reasoning. .
This week’s data in the UK included the labour market and GDP reports, whilst in the USA there was an update to the inflation figures. True, economic growth is not particularly strong in the UK at present, with many sectors restrained by a shortage of key parts, raw materials or labour. However, the economy is still on course to return to its pre-pandemic level in the first half of 2022. The labour market reports showed solid employment growth taking the unemployment rate down to 4.5%, and strong pent-up demand with vacancies well above 1 million. Although average earnings growth dipped a little, and there were various base effects and compositional issues for technicians to examine, wages were reported growing at a historically high rate of 6-7% year on year depending on whether bonuses are included or excluded.
The situation in the UK is, of course, mirrored in most other developed countries, as this week’s updated economic forecasts from the IMF confirmed. The Fund’s Chief Economist stridently warned that central banks should be extremely vigilant about inflationary pressures. This was brought home by the latest inflation data from the USA, which reinforced market expectations that the Fed will need to move on tapering and then rate increases in coming months. Not only did the annual rate of inflation return to 5.4%, the highest since 2008, the driving forces were wide ranging: rent and food, gas and electricity, furniture and new cars, TVs and restaurant meals. It was little surprise that the minutes released from September’s Federal Open Market Committee meeting suggested that reductions in bond purchases could start next month
The net result of all this information has driven UK benchmark bond yields to 1.1% and their US counterpart above 1.5%. Where next? All eyes are on future energy costs of course – it has been estimated nearly half of US households warm their homes with natural gas so they can expect to spend an average of 30% more on their bills compared with last year. UK heating bills will similarly jump again next spring. It should not be forgotten that other sectors are also seeing longstanding price rises. Housing is a prime example. US rental costs last month showed their largest monthly increase since 2001. The overall cost of shelter overall makes up over 30% of the US CPI index. Lastly, business surveys suggest that supply chain disruptions will last well into next year. Market expectations of future inflation are beginning to price in a sticky period rather than a transitory inflation cycle.
It would take a major economic shock to cause central bankers to change their minds, and comments from the likes of MPC members Andrew Bailey and Michael Saunders suggest that they have strong convictions about what to do next. It is sensible for markets still to price in moderate rather than aggressive moves in interest rates, however. A major reason for restraint was signalled by the IMF in its latest Fiscal Monitor, namely the global pandemic has trigged a 14% jump in global debt to a record high of $226 trillion. Central banks do not wish to destroy the finances of the public or private sectors through their actions. Let the wind fill the sails and the boat moves merrily along, whilst dark clouds are a long way away on the far horizon.
Andrew Milligan is an independent economist and investment consultant. This note should be considered 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