Markets Weekly Podcast - 12 Oct 2020

Welcome to your first Markets Weekly podcast. Our host Henk Potts, Market Strategist for EMEA at Barclays Private Bank, gives an overview of market movements from the past week as well as what we can expect in the week ahead. In our guest spot segment with Jai Lakhani, Investment Strategist at Barclays Private Bank, we discuss whether central banks can reflect the global economy, the outlook for inflation and what steps investors may be able to take to position their portfolios for this.

Henk Potts (HP): Hello, it's Monday the 12th October and welcome to the Barclays Private Bank Markets Weekly podcast. The weekly recording that will guide you through the turmoil of the global economy and financial markets. My name is Henk Potts, market strategist for Barclays Private Bank and each week I will be joined by guests to discuss both risks and opportunities for investors.

This recording will last around 15 minutes, broken down into three component parts. Firstly, I'll analyse the events that moved the markets and grabbed the headlines over the course of the past week and then move onto our focus section where we spend a few minutes discussing a specific investment theme.

This week I'm pleased to say that we're joined by a special guest Jai Lakhani, investment strategist with Barclays Private Bank. We’ll discuss the outlook for inflation, how effective central bank policy can be in reflating economies, and the resulting potential risks and opportunities for investors.

And finally, I'll conclude by previewing the major events and data releases that are likely to shape the week ahead.

But first let's start by reviewing markets last week. It was a positive yet volatile week for risk assets as investors bet additional US stimulus will be forthcoming, central banks will remain supportive and progress on a vaccine will eventually mitigate the impact of the pandemic, all of which helped to offset fraught political negotiations on both sides of the Atlantic, disturbing virus headlines and fears of tighter regulation in the tech sector.

In terms of performance highlights from last week: US stocks rallied, the S&P 500 was up 3.8% - in fact posted its biggest weekly increase since July - Treasury yields were mostly flat, the dollar eased back. In Europe the STOXX 600 posted its second consecutive weekly gain, rose 2. 1% over the week.

That's the most in almost four months. Energy shares registered their biggest weekly gain since June as crude prices rose after hurricane Delta resulted in a near total shutdown of crude output in the Gulf of Mexico.

But once again it was President Trump that took sentiment on a roller coaster ride last week as investors focused on his medical prognosis, stimulus negotiations and election development.

While fears over the president's health reduced as he left hospital much earlier than expected, it was the tweet announcing that he was ending stimulus talks until after the election that was the catalyst for much of the price swings witnessed over the trading week.

I think markets were temporarily caught off guard because there had been signs that gap was narrowing. The Fed warned that the recovery would stumble without support. With only a few weeks until Americans head to the polls it was seen as a high stakes move.

However, the president appeased nervous investors by offering support in a piecemeal fashion. He also hinted at a larger package to come if he's re-elected. So what is the chances of future stimulus?

Well, overcoming the political impasse against the backdrop of a divisive presidential election was always going to be difficult. Future US stimulus I think is still very much on the agenda, it’s still a question of when not if.

Additional support is most likely to come at the start of next year, the scale of which of course will depend on the result of the election. There is an argument to suggest a Democratic clean sweep would suggest a larger scale policy response.

We would reiterate while additional stimulus is required and would be supportive of both sentiment and the speed of recovery, it’s by no means a silver bullet that can radically change US growth trajectory.

Medium term US growth prospects continue to be dimmed I think by the development testing the distribution of a vaccine as well as the broader policy agenda from the next administration.

On the data front last week there were further signs that a diverging recovery between the US and Europe is playing out. In the United States there was a positive ISM report, providing an indication the economic recovery is spreading to the all-important service sector.

US service industries expanded in September by more than forecasts, helped by faster growth in new orders. Rising activity is also leading to a pickup in employment in the sector.

The figure in combination with the improvement in the manufacturing gauge suggests the economic rebound is gradually broadening, even if activity remains below pre-pandemic levels in various sectors.

Different peaks I say emerging in Europe, the French economy is now projected to stagnate in the fourth quarter as uncertainty and the risk of lockdowns impede upon investment and consumer spending. Insee, the country's statistics agency, downgraded its growth forecast to 0 from 1% in the three months to the end of this year.

The French service sector is particularly downbeat. Households fear of rising unemployment is also filtering through to weaker demand expectations. What does that mean in terms of the European recovery?

Well, adds to the evidence the euro recovery has been losing momentum as European governments struggle to balance economic activity with the need contain the resurgent virus, all of which is increasing pressure on policymakers to ramp up the response.

The expectation is the European Central Bank will increase its bond buying programme at its December meeting.

In the UK a similar bleak picture emerged from the latest growth figures. In August the 2.1% month on month rise in activity was substantially below expectations. Markets were looking for a figure closer to 4.6%.

Growth came from services but that was primarily driven by the ‘eat out to help out’ scheme and ‘staycationing’. Industrial production and construction growth slowed quite significantly. GDP levels are now 9. 2% below February’s levels.

The triple threat of rising unemployment, tighter restrictions and Brexit uncertainty certainly points to a softer final quarter for the UK economy and a full year contraction that could come in at 10%.

In terms of corporate news, the House Judiciary antitrust 449-page report on the technology sector was the headline grabber. The investigation in its own words ‘revealed an alarming pattern of business practises that degrade competition and stifle innovation’.

They claim that Google overwhelmingly dominates the search market. They said that Apple, Facebook and Amazon have monopoly power in various areas of their operation.

The committee recommended some stark reforms including imposing structural separations, prohibiting dominant platforms from entering adjacent lines of business, tougher merger and acquisition approval process, and measures to rent platforms from preferencing their own services.

What does report mean for the tech sector? Well if implemented of course it would have significant impact on current and future business models. The damning report I suppose to some extent does highlight the potential regulatory risk to the sector.

However, the current political will to push ahead with wholesale reforms still looks very limited, although that of course could change and could increase under a Democrat controlled White House and Congress. From an investment perspective what does it mean for the sector?

I think if outsized regulatory fears exacerbate price weakness it could provide an opportunity for investors to add suitable exposure to US large Cap tech stocks, a sector that we still believe looks attractive from a fundamental perspective.

With that, let's move onto our focus section. Jai, good to have you with us once again today.

Jai Lakhani (JL): Thanks Henk, happy to be here.

HP: Current and future inflation expectations we know is a critical component of an investment strategy calculation. Central banks over the course of the past decade have persistently failed to achieve their inflation target levels.

Why is this and, perhaps more importantly, can we assume that inflation will remain depressed for a prolonged period of time?

JL: Sure, this is very good question and I think if we answer the first part we have to acknowledge the big role central banks have had in driving inflation down with the various measures that they've done when inflation was above the target, and this has been one factor that has increased their credibility whenever they are suggesting monetary policy be tighter.

However, if this was the only factor, just as well as they were able to bring inflation down they'd be able to bring it back up when it did dip below target. So obviously there are other factors at play and one factor in particular globalisation which has meant that markets have become much more contestable, thereby eroding the market cost.

This has meant that any rise in input costs caused by exogenous shocks in the past, which were persistent, are no longer the case, they are no longer step changes. And a clear outcome as well of globalisation has been rapid technological advances, which has shifted production to the emerging world and pushed costs down.

As the Bank of England Monetary Policy Committee member Jonathan Haskel argues, these technological advances have helped contribute to a flattering Phillips curve and the link also appears to be weaker during lower periods of growth that we have seen so far.

Does this mean however inflation is dead? Well we need to, as Claudio Borio argues, focus on the economic time period and distinguishing between shorter term and longer term dynamics.

Over the following 1-3 years, or the shorter term so to speak, downward inflationary pressures are likely to prevail and the global economy should see excess capacity for some time. During such a period any cost push pressures are likely to be temporary as opposed to permanent.

However, a theme we talk about in our thematic article is a push back from globalisation that we've seen in the past few decades and a new world order where firms move supply chains inward, change the political environment fostering de-globalisation and fiscal stimulus measures may mean inflation may have hibernated for a long time but it is just hibernating and it is waiting to burst to life.

HP: So that’s very interesting. So, what more can central banks do to help reflate economies?

JL: Well I think there needs to be a change in the policy measures in terms of how we look at it. So a global Phillips curve would imply that a national policy measure may not be sufficient and global central bank coordination may be needed to help tackle the dilemma.

Also it's as Adam Posen, President at Peace Institute for international economics, summarised the issue in football parlance, that it is much easier to play defence than it is offence.

We've seen this with Japan, the ECB, and whilst we have now seen the Fed's inflation review framework changing and allows inflation overshoots over a temporary period of time, it does take time to alter the process and ultimately there is only so much central banks can do. Coordination with fiscal stimulus is needed.

HP: So can fiscal policy really provide the answer? How constrained is it?

JL: Well sure. I think when we look at the pandemic I think what we need to remember is that emergency situations call for emergency measures.

The fiscal stimulus and the unprecedented monetary stimulus that we got was the right response as it avoided liquidity traps as central banks for the most part bought up government debt and it will take both parties moving together.

The concern is when these two diverge as you so rightly say, policymakers face pressures to avoid a high public debt to GDP ratio. But the question should be, are we there yet?

The issue of high debt is more a concern if interest rates move upwards (i.e. the cost of rolling over that debt becomes too high).

With interest rates globally at record low, the cost of new debt is low. With the central bank having a bias to tolerate overshoots in inflation as well the room is arguably there for fiscal stimulus and this could be the game changer.

HP: Finally, let's think about what that means for investors. How should they be positioned in terms of their portfolio in light of the factors that you’ve alluded to today?

JL: Sure so as we discussed in this new world order, we're likely going to see a move away from global integration, fiscal policy altering consumer spending and circulating in the economy.

And whilst this will happen, it's not going to happen overnight but it definitely appears to be on its way. Additionally, central banks may tolerate any fears of higher inflation more than previously to accommodate recovery from the scarring effects this pandemic has had.

As such there is potential for more upward movement in inflation markets and a higher inflation profile than the previous decade.

So for investors looking to shield their portfolios from the risk of significantly higher inflation, they may want to consider active management and a preference for quality companies and assets that tend to outperform in inflationary environments.

HP: Well thank you very much Jai for highlighting the important inflation outlook, a topic I’m sure that we will return to in the future.

Let's move forward to think about what we should focus on this week. Markets should gain a better understanding of the likelihood and scope of the Brexit deal ahead of the EU summit on Thursday and Friday.

However, hopes that EU heads of states would be reviewing a draft of the UK/EU trade agreement have all but disappeared.

It looks like the negotiations will have to continue into the second half of this month. On the data front, investors will closely monitor the US inflation and retail sales numbers along with the UK labour market report.

Against a backdrop of suppressed economic activity, inflation rates remain generally subdued, however the US core September Consumer Price Index is expected to rise by 2/10 of 1% month on month taking the annualised figure to 1.8%.

UK unemployment rate as we know has remained fairly low while furloughed workers are classed as employed, however with the first changes to the government scheme requiring employer contributions introduced in August the unemployment rate is expected to tick up.

Markets anticipate it to rise to 4.3% compared to 4.1% the previous month, we get those figures on Tuesday. And the expectation is of course, worse is to come when the new job support scheme begins in November.

Finishing off on Friday with the September retail sales numbers from the United States which will signal the health of the important US consumer after the weaker than expected August report which was largely due to the drop in government pandemic protection payments.

September's figures will indicate if the recovery is still continuing, albeit slowly. US retail sales are forecast to rise 6/10 of 1% month on month.

With that I'd like to thank you once again for joining us. We hope that you found this podcast interesting, informative, and it's giving you a guide as to how you should be thinking about your portfolio from the inflation perspective.

We’ll of course be back next week with our latest instalment but for now may I wish you every success for the trading week ahead.