Market Perspectives September 2023
Read our latest round-up of the global themes, trends and events currently influencing investors.
04 September 2023
Julien Lafargue, CFA, London UK, Chief Market Strategist
In July, China’s consumer price index fell by 0.3% year-on-year (see chart). Although deflation, or lower prices, wasn’t a total surprise (economists surveyed by Bloomberg expected a larger contraction, of -0.4%), it made for scary headlines. Clearly, deflation is never the sign of a healthy economy. However, in this particular case, there are some elements that are worth considering.
First, meaningful changes in the comparable data, or so-called base effects, from last year were at play: in July 2022, China’s inflation was 2.7%. In addition, the drop in prices was driven by a few categories in particular. For instance, the cost of food (-1.7%) and pork (-26%) saw significant declines, again linked to base effects. Similarly, transport and communications (-4.7%) reflected weaker fuel prices.
Taken together, food and transport prices subtracted more than 20 basis points of the overall headline inflation. In fact, core prices (excluding food and energy) were up 0.8% in July, an improvement on June’s 0.4%. The other important question investors should ask themselves is whether a slowing Chinese economy is good news.
The answer is probably yes. Indeed, if the country was firing on all cylinders, US and European nations might not have seen inflation drop by as much as it has in recent months. The result could have been increased pressure on central banks to hike interest rates and making a recession more likely.
China’s consumer price index records year-on-year fall for the first time since 2020
In the second quarter of 2023, more than 6,000 companies filed for bankruptcies in England and Wales, a level not seen since the global financial crisis of 2008-2009 (see chart). The spike in the number of company failures might be attributed to the tougher macroeconomic times and the aggressive rate hikes seen from the Bank of England to tame inflation. However, there is also a hint of mean reversion.
Indeed, as counterintuitive as it may seem, the number bankruptcies collapsed during the pandemic, courtesy of significant government support. If the data is smoothed and the pre-pandemic period between first-quarter (Q1) 2017 and Q1 2020 is compared with Q2 2020 to Q2 2023, the number of insolvencies in the latter group is “only” 10% higher.
The flipside is that with government support having now been removed, married with higher labour costs and increased debt financing expenses, it seems only a matter of time before the Q4 2008 quarterly record of 7,000 bankruptcies is broken.
The combined number of receiverships, company voluntary arrangement, administrations, creditor voluntary liquidations and compulsory liquidations seen this year is the most seen since 2008, in England and Wales
The US consumer price index (CPI) plummeted to 3.2% year-on-year in July from 9.1% in June 2022. The main drivers behind the ongoing disinflation trends are well-known: lower energy prices, favourable 2022 comparable data and moderating aggregate demand in the economy.
However, one part of the CPI basket has been refusing to give: shelter costs. This is important: housing-related costs represent around a third of the CPI basket.
If shelter costs were excluded from the headline CPI calculation, US inflation would be around 1% (see chart). The next moves in US interest rates could be influenced heavily by how property rental prices change in the coming months. On this front, the outlook is rather constructive. In fact, the Federal Reserve Bank of San Francisco itself published a model suggesting that shelter inflation could turn negative by mid-20241.
US shelter costs have started to ease, and are forecast to do so for some time. Meanwhile, consumer prices, excluding shelter costs, have collapsed and are at levels last seen in 2020
UK rents are set to increase at the fastest pace seen in recent years, as interest rates continue to climb (see chart). House prices have been resilient to higher rates so far. In fact, they were up 1.7% year on year in June, according to data published by the Office for National Statistics. Although this is the slowest increase in prices since the pandemic (June 2020), it is still impressive in the context of mortgage rates having more than tripled in the last two years.
What is maybe even more surprising is the surge in rents. Indeed, according to July’s retail price index, rental costs shot up by 7.3% year on year. Two effects seem to be at play here. First, some landlords who borrowed to purchase, and then rent, a house (“buy-to-let”), may be looking to align their rental income to skyrocketing mortgage repayments.
Second, with housing affordability being challenged, some potential buyers might be forced into the rental market, boosting demand while supply remains limited. In any case, this trend does not appear sustainable and rent prices will ultimately settle down. Meanwhile, cash buyers should be able to pick up some good deals from struggling landlords.
The housing rentals component of UK inflation and the sterling two-year (75% loan-to-value) buy-to-let fixed mortgage rate has surged since 2022
The US manufacturing sector rebounded in August (see chart), according to the Federal Reserve of Philadelphia’s (“Philly”) business survey. Indeed, the Philly index has turned positive for the first time since August 2022. This suggests that the manufacturing downturn seen over the last twelve months is coming to an end.
It is dangerous to assume that the COVID-19 pandemic is a thing of the past simply because people are free to travel around the world again or leave their face masks at home. The economic disruptions caused by widespread lockdowns will reverberate for years to come.
After primarily having spent on goods rather than services during the pandemic (triggering a manufacturing boom in 2021), consumers have unleashed their “revenge spending” on services, travel in particular, once economies and borders started to reopen (the 2022 bust in manufacturing). This downward part of the cycle seems to be ending, and last year’s collapse in activity is likely to be the precursor to a rebound in 2023 and 2024.
The Philly Fed’s manufacturing business outlook survey (whether on a current or three-month average basis) hints at a resurgent US manufacturing sector this year
Read our latest round-up of the global themes, trends and events currently influencing investors.
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