Financial update from Brewin Dolphin 22 April 2022

April 2022

The Weekly Round-up

Friday 22 April 2022

In his latest weekly round-up, Guy Foster, our Chief Strategist, looks at the outlook for inflation and considers policymakers’ efforts to tame it.

Some of the most fascinating times for markets come when policymakers find themselves in confrontation with the markets. Sometimes their position is untenable, and I always recall the ill-fated efforts of the Bank of England to maintain the pound’s position within the European Exchange Rate Mechanism (ERM) before conceding defeat. On other occasions policymakers have shown themselves capable of having the will and ability to tame troublesome markets, as when Mario Draghi proclaimed “within our mandate the European Central Bank (ECB) is ready to do whatever it takes to preserve the euro. And believe me”, he added, “it will be enough.” That was enough to reverse the dispersing borrowing cost that threatened to tear the eurozone apart.

Now a different group of central bankers find themselves trying to convince the markets that they have a similar level of absolute commitment to holding down inflation. So far, they are not managing it.

Rate expectations

Comments from Fed members have certainly managed to skew interest rate expectations higher. There are now an average of 50 basis points of interest rate increases expected at each of the next three meetings. Comments from regional Fed chief James Bullard suggested that we could have 50 basis point increases at each of the remaining six Fed meetings. He also refused to rule out a 75 basis point increase at the next meeting, although it sounds unlikely.

Federal Reserve Chairman Jay Powell bolstered interest rate expectations further by lauding the benefits of front-loading interest rate increases.

Ordinarily these kind of expectations would be enough to flatten the curve as investors anticipate recession and the impending need to cut interest rates again. It’s unusual to see it steepening further and implies that markets keep raising their estimate of where the neutral rate of interest lies.

Economy still strong for now

Part of that may be driven by the continued momentum behind the economy. The US housing market is a big driver of economic activity. It seems well supported by demand. New housing starts, and permits to build new houses, both expanded at their fastest pace since 2006 in data released this week. Housing is involved in a push and pull between demand and supply related forces. Currently demand for housing cannot be met which has provided very solid demand. However, that will reduce as mortgage rates rise, driving down affordability. This is a growing concern to housebuilders and caused the NAHB homebuilder sentiment index to fall to its lowest in seven months.

Investors look to surveys for the most up to date hints at where the economy is going. Purchasing managers indices released this morning continue to suggest it is strong. In Japan, the service sector emerged from an implied contraction as covid rules have been loosened. The UK, having been amongst the first countries to end lockdown, continued to expand albeit at a slightly slower pace.

In Europe, the service sector continues to expand at an accelerating pace, notwithstanding the cost of living crisis and inflationary impact.

The strength of the recovery encouraged some ECB members to discuss raising interest rates too. Investors expect the ECB to halt asset purchases in June and raise interest rates as soon as July.

The US earnings season has been revealing. The inflationary environment obviously brings its own challenges, but many firms are still trying to establish what their post-lockdown growth trajectory will be. Most obviously, for Netflix it has been revised down sharply as the company suffered a fall in subscribers. The reopening economy and potential for consumer belt-tightening creates twin possible headwinds for streaming services. Overall, with a fifth of companies having reported in the US, just under 80% of them have beaten earnings estimates and well over half of them have beaten on sales. These numbers are in line with historical averages but rarely provide much insight into the strength of the US corporate sector. Instead that tends to come through company guidance and its incorporation into future forecasts.

China

After a lot of push and pull, markets have ended this week pretty flat. China however has lagged most regions. There’s been plenty to not like about China this year with the regulatory clampdown on technology stocks, the aggressive lockdowns to try and maintain zero covid cases and the struggling property sector.

Those stories have however overshadowed the fact that the renminbi has been strong, China has grown its share of global exports and central banks are finding reason to add the Chinese currency to their stocks of currency reserves. With sentiment so beaten up and a critical story on the cover of The Economist (which tends to be a contrarian indicator), perhaps Chinese stocks may be starting to look interesting again – particularly since last month the authorities seemed to indicate they were shifting their attention away from curtailing the Chinese technology giants.

French election

This weekend sees the run-off to determine who will be France’s president, the incumbent Emmanuel Macron or the challenger Marine Le Pen. Le Pen’s stance has softened in recent years, presumably in an attempt to become more electable. This saw her prosper in the first round. However a greater focus on the two remaining candidates seems to be working in Macron’s favour. Polls and betting markets give Macron a decisive lead and consider his second term a near-certainty. They’re probably right but, since the markets have had a bad few years forecasting populist elections results involving populist candidates and topics, it is worth considering the alternative outcome.

Le Pen can draw on a deep well of dissatisfaction with the EU according to the bloc’s own Eurobarometer survey. Only Greeks are more pessimistic about the EU’s future than the French. And the French manage to distrust the EU more than any other member (including the Greeks).

A Le Pen victory would be considered a bad outcome by the markets. Although French attitudes are positive towards the euro it is anticipated that le Pen would weaken the EU from the inside by violating treaty obligations and undermining the bloc’s cohesion. She also wants to loosen French ties to NATO.

Her last chance to try to arrest the sliding poll ratings was a debate this week which does not seem to have aided her chances. And while there have been polling errors in high profile elections in the past, French run-offs typically have quite a narrow margin of error.