MUNIX WEEKLY
Turning the super tanker around
A small but significant event took place a few days ago. The German ten-year bond yield moved from negative into positive territory. Of course the shift of a few basis points hardly matters to most investors, but this was the first time that the German benchmark bond had been in positive territory since 2019. Indeed the total amount of negative yielding bonds across the world had reached a peak of $30 trillion during the course of the pandemic. As investors have reappraised the prospects for growth, inflation, and hence monetary policy that negative debt mountain has shrunk in size to under $8 trillion.
Monetary policy, like super tankers, cannot be turned around quickly, well certainly not without immense strain and stress on the vehicle. In recent months central banks around the world have tried to take a step-by-step approach, warning investors and then beginning a series of small interest rate increases and changes in bond purchase programmes. On some occasions the captain will call down to the engine room – more speed! Such was seen this week with the decisions by the Bank of England and ECB. Of course there will be debates about the speed and pace of policy moves, even a super tanker will need to change direction to avoid the shoals and rocks, but the overall direction is abundantly clear – that is unless a major storm blows up, such as the situation in the Ukraine.
The Bank of England did not want to upset markets. Andrew Bailey and Catherine Mann had already warned that businesses’ price and wage growth expectations were not consistent with hitting the inflation target, and monetary policy needed to temper that risk. The MPC duly raised interest rates once again, just as most commentators had expected, the first back-to-back increase since 2004. Consumer price inflation had reached a 30-year high of 5.4% in December, with most forecasts suggesting the peak would not be until April, when higher energy costs mean 6-7% could be seen. The latest Citi/YouGov survey of the public’s inflation expectations shows people are more pessimistic about price growth in the coming year than at any time since 2006.
However, investors were surprised by two aspects of the MPC statement. The first was that 4 of the 9 members had actually voted for a 50bp rather than a 25bp rate hike, such was their desire to give a strong signal. The second was agreement to run down the Bank’s corporate bond holdings this year via a mixture of sales and no further re-investment. Once base rates reach 1% the Bank has indicated it will consider sales of its gilt holdings too.Under its Quantitative Easing programme the Bank has purchased almost £900 billion of gilts and corporate bonds over the past decade.
A further point for the MPC to assess in April will be the extent of the rise in the energy cap and how much this will be reduced by the Chancellor’s decision to provide a subsidy. This could lower the future peak in inflation by 0.25-0.5%, but only for a year. The Bank has already warned that the CPI peak should exceed 7%.
The MPC is not the only group of people wondering when inflation might peak. The latest European inflation report was worse than expected, at 5.1% a year a record high since the euro’s inception. This week’s ECB meeting doubtless involved another strident, behind the scenes, discussion between the hawks and the doves. Although wages are currently well behaved, Eurozone unemployment has reached a record low. Despite repeated protestations to the contrary from Christine Lagarde, as she emphasises that energy prices and supply-side constraints are driving eurozone inflation in the short term, economic reality and the weight of debate caught up with her, meaning a more hawkish or perhaps realistic statement. The markets had already priced in moves worth 0.2% this year but after the ECB press conference this changed to moves worth 0.4%. All eyes will be on March’s meeting for signals about cuts to the QE programme.
Even a super tanker can also have fine touches on the tiller. After last week’s hawkish comments from Jerome Powell, four Fed officials spoke this week, each emphasising the need for gradual tightening and the need for moves to be data-dependent.
The speed with which a super tanker moves matters for another reason, the wake that it leaves behind. This week also saw the announcement by the US Congressional Budget Office that total public debt had reached a new record of $30 trillion. That was a nearly $7 trillion higher than a year before. Over time, interest rate increases will inexorably raise the debt servicing costs on the U.S. and of course all major economies. The unproductive spending behind the debt has also pushed real or inflation adjusted bond yields into negative territory. The Economist estimates that households, companies, financial firms and governments worldwide paid around $10 trillion in interest costs in 2021, equivalent to 11% of GDP. Together with higher energy costs, the world economy faces a noticeable squeeze on spending power in the coming year.
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