Finally, Some Stability

Week Ending 28th October, 2022

In this week’s update the UK finally seems to have some sort of stability, but where will the GBP go from here? US Q3 GDP saw a strong rebound from the past two quarters; however, Europe saw some rather disappointing inflation prints. As for the markets, this week had something of a risk-on feel to it as global equity funds saw inflows and global bond funds saw outflows.

Continue reading for the full weekly update:

UK Update:

We finally seem to have some stability! Through the revolving door, Liz Truss exits, and Rishi Sunak enters. His message is loud and clear – prudent finances. With a black hole to plug of anywhere between £30bn and £50bn, tax rises and spending cuts are definitely on the cards at the next budget which has been deferred to mid-November. Meanwhile, the GBP has currently settled around the 1.15 to 1.16 level to the $. Importantly, the UK 10y Gilt is yielding around 3.46% - returning it to pre-political risk premium level. This is key as it reduces debt servicing cost to the tune of some £10bn – giving the Chancellor some room to manoeuvre.

The direction of the GBP, from here, is the next big question for GBP investors. The downside is starting to become limited under the new Administration. The market has taken to it well and there seems to be communication with the BoE. It doesn’t mean the economy is fixed – far from it. The fundamentals don’t look great. However, it’s like watching a replay of 2010 when an austerity budget was introduced. It all comes down to what growth-promoting policies the Administration can conjure up that will determine the path for investment, especially foreign direct investment. We don’t see domestic demand boosting growth – most people are in tightening mode. Recession risk is real. Foreign monies will be the main influencer that could boost the GBP. It will be a slow process. What the BoE does is also a determining factor – they will be paying due regard to fixed-rate mortgages that reset. If they are satisfied government finances are being properly controlled, they might just ease up on the size and scale of rate hikes. After all, they did backtrack on Gilt sales!

US Q3 GDP:

Saw a strong rebound to 2.6% y/y. It fully reversed the declines from the previous two quarters, but was helped by a strong boost from a much smaller trade deficit which added 2.77% to GDP growth y/y. Underlying components look soft e.g. Consumption growth slowed to +1.4% y/y, structures investment declined again (residential -26.4%, non-residential -15.4%), while equipment investment rebounded strongly +10.8%. Government spending was strong (+2.4%). The drop in domestic demand slowed to 1.4% (from 2.0%) is somewhat worrying and suggests a slowdown is underway. Business inventories subtracted -0.7% from GDP growth. Friday’s consumer spending shows the consumer is not giving up just yet as spending outstripped PCE inflation (0.6% vs 0.3% respectively). Private sector finances (households, corporates and small businesses) remain positive & healthy thanks to the pandemic surpluses

Europe:

Saw some disappointing inflation prints while the ECB voted for a 0.75% rate hike. Three policymakers wanted just a 0.50% hike. The € resumed its downward path. Europe is being largely impacted by headline inflation (energy) – core inflation is not as persistent as seen in the US and UK. Italy’s headline rate jumped 4.0% m/m to 12.8% y/y while Germany’s headline rose to 11.6% y/y

As shown in the market summary table below, the week had something of a risk-on feel to it. For some (e.g. UK), there were idiosyncratic factors at play but, overall, the main driver is the notion we might be approaching the end of the rate hiking cycle across many of the Developed nations. Some of this is based on the idea inflation is becoming tempered. For the most part, you have to question how much pressure CBs can keep putting on consumers who are already battling inflation. Which would you rather have – an environment in which the consumer just has to accept a decline in living standards in real terms or a global economy which simply breaks under rising rates sending everything into a tailspin?

MARKET SUMMARY

For w/e 28th October, global equity funds saw inflows of $7.8bn with US funds benefitting the most ($7.9bn). Asian funds enjoyed $2.1bn but European funds saw outflows of -$2.3bn. MM funds had substantial inflows of $18.6bn as recession worries remain. Global bond funds saw net outflows of -$4.9bn.