MUNIX COMMENTARY – 17th September
You wait ages for a bus and then several all come at once!
After several weeks when bond markets traded in a very narrow range and investors appeared to take little notice of the statistics reported in the major economies, a series of inflation reports have had a noticeable effect. The UK data was worse than generally expected, whilst problems are also being seen in other economies. The UK 10-year gilt yield has risen to 0.8%, its’ highest since June. The consensus view now is that the Bank of England will raise interest rates to 0.5% by the end of 2022.
The UK data was quite shocking, although as with many of the reports at present numerous special factors need to be taken into account. The bad news was that headline CPI reached 3.2% year on year, its highest since 2012. Indeed the old fashioned RPI measure was up as much as 4.8% from a year ago. Part of this related to the Chancellor’s efforts to encourage people to visit pubs and restaurants a year ago, part related to much more expensive second-hand cars, whilst food and fuel also played their part.
This is far from the first time that inflation has surprised to the upside. Indeed, one reason why the markets are becoming more concerned is that the Bank is not covering itself in glory with its short-term forecasting. As recently as May, it thought the annual rate of inflation might peak around the end of 2021 at 2.5 per cent; now it is suggesting 4% is a more likely figure. More bearish forecasters are thinking a figure closer to 4.5%.
The UK was by no means the only economy to see high rates of inflation this week. The US and Canadian figures were also eye-catching, if not as alarming. Headline inflation in Canada is up 4% from a year ago, in the USA it eased marginally to 5.3% in the year to August. Even stripping out food and energy, the core rates are as high as 3.5-4.0%. One piece of good news was that various hotspots began to moderate, so used car prices, airline fares and hotel charges in America were all lower; as the economy opens up, so there is a better balance between demand and supply.
The overall picture remains a concern though to economists. Even after special factors such as tax changes or lockdown effects have been removed, a clear upward trend is in place, not only in the UK but across Europe and North America too. It is also clear that several forces mean this uptrend will continue 2022. Housing has become much more expensive in the past 18 months, which feeds into a technical measure known as ‘owner equivalent rents’. Energy costs are also becoming a cause for concern – UK fuel bills will see a major increase in October, but a mixture of unhelpful weather patterns and overseas supply disruptions mean even more expensive energy into the winter.
Central banks have indicated they will respond appropriately. The market assumes that the Fed will discuss QE tapering in September and begin in November, followed later by interest rate increases. Fed Governors are expected to decide on a steady path, one rate move in 2022, then two in 2023 and two in 2024, adding up to 1.25% over the 3 years. Financial markets are starting to price in such moves; a recent survey by Deutsche Bank reported that a net 73% expect higher US Treasury yields in a year’s time.
How far yields will rise will depend on the answers to some complex questions, in all the major economies Will the rise in inflation prove transitory or is a regime shift taking place? Will labour market data indicate that wages trouble is brewing on the horizon? How quickly can some of the supply bottlenecks be closed, or will the problems in some areas, such as basic semi-conductor chips or transportation costs, last well into 2022, perhaps even 2023.
In this regard this week’s employment report in the UK also contained some important information. There was another fall in the unemployment rate, amidst more signs that companies have vacancies which they cannot fill. Average earnings excluding bonuses are 6.8% higher than a year ago, whilst the figure including bonuses has reached 8.3%. If there are more second
round effects from companies raising prices to balance supply and demand, then the Bank’s forecasts and market expectations of future rate increases can only move one way.
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