It has been a quiet week with both equities and bonds trading in a narrow range
We did see a bit more movement in currencies with Sterling bouncing and Gilts underperformed on the back of UK inflation data remaining stubbornly high.
The updated inflation data for the UK saw CPI at 10.1% year on year in March, down from 10.4% in February but above the 9.8% level expected, and well above the 9.2% predicted by the Bank of England. This was the 7th consecutive month with CPI over 10%. UK inflation is becoming something of an outlier, and is looking stubbornly high compared to the US, where inflation has eased to 5%, and the eurozone, where March inflation was 6.9%. Energy costs have not fallen as sharply as in Europe – this is thanks to the way prices are fixed so the drop will come in time, but wage growth appears sticky thanks to the tight labour market. The wage data, published earlier in the week highlights the struggles the Bank of England has in getting inflationary pressures in check. Wage growth, at 5.9% year on year was well ahead of expectations, though of course in real terms it remains negative.
The UK looks a lot closer to a ‘wage-price spiral’ than its developed market peers. The UK unemployment rate did climb slightly, to 3.8% in the three months to March but remains close to the cycle lows. The easing in motor fuel prices in UK inflation data was offset by rising food costs, with the Office for National Statistics noting that the cost of food “is still climbing sharply”. That seems like a mild understatement when you see the numbers – CPI for food and non-alcoholic beverages was up 19.1% year on year in March – the fastest pace in 45 years. The Core CPI data, which excludes food and energy was unchanged at 6.2% year on year, higher than expected. A further 25 basis point rate hike from the Bank of England at their 11 May meeting looks like a certainty, with upside risks to the view that this would be the final rate hike for this cycle.
Elsewhere in the economic numbers we have seen China reporting first quarter GDP growth of 4.5% year on year, stronger than expected but below the 5% target for the year. With China’s economic momentum likely to accelerate, the annual growth target looks set to be met, if not surpassed. We’ve seen plenty of upgrades to growth forecasts this week on the back of the data for the first quarter, but while China’s domestic economy appears to have decent traction, a slowdown or recession in developed markets could still be a significant headwind. The end of zero Covid restrictions has seen a very strong rebound in consumer spending but the recovery in the economy does look somewhat uneven as highlighted by some of the other data published. Retail sales were up 10.6% year on year in March, well ahead of expectations, but fixed asset investment (i.e., capital expenditure) missed expectations, up 5.1%, and industrial production was also below expectations, at 3.9%.
For a broad-based recovery, stronger data from the all-important property sector will also be needed. In Q1, new housing stats were down almost 20% compared to Q1 2022, with real estate investment down 5.8%. A further challenge comes from unemployment, with a record level of 20% of Chinese youths out of work. For now, the solid Q1 data suggests no immediate need for further stimulus, but if we do see the pace of growth easing, or the slowdown in the West having an impact, there remains scope for both fiscal and monetary easing to support the economy as well as targeted policies for property and infrastructure.
As we move closer to the next Federal Reserve rate setting meeting, market expectations for another increase in interest rates have continued to grow, as the banking related turmoil of March fades and the focus returns to the resilience of the US economy even if the data is slowing. Market expectations as measured by Fed Funds Futures show an 88% probability of a 25 basis point hike when the Fed meets on 3 May. Ahead of the ‘blackout’ period for speakers before the meeting, we’ve heard from various Fed governors this week, all of whom have pointed to the need for rates to rise further and remain elevated. Raphael Bostic of the Atlanta Fed said his baseline was “one further hike, and then a pause” that left rates at that level “for quite some time”. Tom Barkin, of the Richmond Fed said he “wants to see more evidence that inflation is settling back to our target”, while the labour market “has moved from red-hot to merely hot”. The Fed will want to see more evidence of a sustained downward move in inflation, and a cooling in the labour market before they contemplate rate cuts, even though Fed Futures are still pricing rates to fall by 75 basis points by year end after one more hike in May. So, there’s still a sizeable gap between what the Fed is saying and what markets are pricing. This gap will close somehow and could be a cause for volatility at some point.
Our rescheduled webinar took place on Tuesday with Scott Spencer and I covering in depth the recent banking issues and the potential hangover in terms of credit availability. We also discussed our portfolio positioning and the recent holding changes that have taken place in the past few months. Please click here for the replay.
