Markets Weekly podcast - 19 July 2021

Henk Potts (HP): Hello. It’s Monday, 19th July and welcome to the Barclays Private Bank Markets Weekly podcast, the 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. Each week I’ll be joined by guests to discuss both risks and opportunities for investors.

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We’ll then discuss the outlook for the UK property market. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Investors had a range of factors to digest last week. The rapid spread of the contagious COVID-19 Delta variant, the latest growth figures from China and the start of the second-quarter earnings season.

But it was surging inflation prints that once again set the tone for financial markets. Investors are increasingly suspicious that inflation is becoming more ingrained than originally predicted. The definition of transitory is higher and longer than central banks have claimed and that’s starting to encourage traders to price in the risk of a faster pace of policy timing.

Turning to sources of inflation, technical statistical factors, the numbers we should remember are exaggerated by the low base compared to last year, the demand-pull side, the relaxation of restrictions and unleashing this pent-up demand from consumers fuelled by stimulus checks and excess savings.

Price pressures are also coming from ultra-accommodative monetary policy and that flood of fiscal support. In terms of cost push, supply remains constrained certainly in labour markets due to enhanced social benefits, childcare issues and fears over the virus.

The rapid global recovery has created supply chain stress while higher commodity prices are pushing up input costs. However, a number of factors suggesting inflationary pressure we have been seeing is transitory. If you look at the level of spare capacity in many economies it remains high compared to the start of the recession which should help to anchor inflationary pressures.

Key labour markets are recovering, particularly in the United States, but a range of indicators such as participation, furlough schemes and headline unemployment rates still suggest plenty of slack.

The rapid digitalisation and the ongoing investment in technology is also expected to keep price pressures muted. We do think supply chain bottlenecks will eventually ease as conditions normalise.

The big number of the week of course was US consumer prices which surged in June at their fastest pace since 2008 smashing expectations for the fourth consecutive month. Headline consumer price index jumped 5.4% year on year. The market was looking for a figure closer to 5%.

Price pressures are emanating from sectors in the United States that are reopening. In terms of the breakdown used cars, airline fares and lodging away from home contributed 58 basis points of the 88 basis points increase in core inflation.

Used cars accounted for a third of the gain in CPI (consumer price index) where the shortage of semiconductors has disrupted production of new cars. Nervous passengers are shunning public transport and dealerships are reporting plenty of that pent-up demand all of which is pushing up the price of second-hand cars.

In terms of the US inflation outlook, near term supply chain bottlenecks we think will continue to drive increases in CPI in specific sectors as the economy reopens but from the third quarter we expect the pace of inflation to moderate more forcefully as many core goods and services apart from perhaps housing give back some of their recent gains.

In terms of the numbers, we now expect headline CPI at 6% year on year in December of this year but back down to 1.9% by the end of 2022.

Market reaction was actually quite muted in the United States. If you look at 10-year treasury yields they fell 5.4 basis points over the week to finish at 1.3%. In testimony Fed Chair Jerome Powell tried to calm investors. He maintained the message recovery hasn’t progressed enough to begin scaling back its asset purchases and inflation is likely to remain high before moderating but did reiterate the Fed remains vigilant.

Turning to the policy outlook, the Fed, we should remind ourselves, has aligned its forward guidance with the intention to achieve maximum employment and 2% average inflation over time. This should give the central bank the flexibility to look through any above target inflation outcomes this year to keep rates on hold we think into 2023. However, given the magnitude of the recovery in both growth and inflation the tapering of asset purchases looks scheduled to start at the November meeting.

In the UK inflation has also been printing high but not registering the same elevated levels but still outstripping economists’ expectations. June CPI came in at 2.5%. The estimate was for 2.2%. The cost of previously owned vehicles rose 4.4% in June. That’s the most since records began in 1996.

In terms of the inflation outlook we now see UK inflation peaking at 3.1% in the fourth quarter, then easing back to average close to the 2% target in 2022. Despite the higher than expected print we still expect the MPC [monetary policy committee] to remain prudent and refrain from signalling anything until it’s able to form a view on the post furlough labour market which would likely be at the February 2022 MPC meeting.

In the meantime we saw last week that individual members of the Committee may step up the inflation narrative highlighting that the bank stands ready to address any sustained inflation overshoot.

Moving on to China, where the economy lost some momentum in the second quarter. Headline growth falling short of expectations. GDP still grew at 7.9% in the second quarter but consensus was for 8.1%. However, when you look at the higher frequency data, which I think is actually probably more closely watched by analysts, it demonstrated resilience in industrial production even though growth slowed to 8.3% in June compared to 8.8% in May.

We know industrial production has been impacted by higher raw material costs, supply shortages and tougher environmental controls. Still, a steady figure coming through from that part of the economy.

The really positive figure actually came in the form of retail sales which rose 12.1% during the course of June. Consensus was for 11% and revised hopes I think of this improving domestic consumption picture which could help to rebalance recovery and support future growth.

What we do know is the People’s Bank of China increased liquidity recently with a cut in the reserve requirement ratio. Markets have been anticipating a further 50 basis point cut in the fourth quarter although this is likely to be determined by the strength of the incoming data.

So that was the global economy and financial markets last week. Let’s move on to consider the UK property market. I’m pleased to be joined by Stephen Moroukian, head of debt advisory for Barclays Private Bank.

Stephen, great to have you with us today. One of the most common questions we get from clients is around the performance of the UK residential property market. When we look at the most recent data, the nationwide figures show UK house prices surged 13.4% year on year in June. That’s the biggest annual increase we’ve seen since November 2004.

Average house prices now stand at an all-time high just over £254,000. So my first question to you is what has been driving this activity and how sustainable is it?

Stephen Moroukian (SM): Thanks. Morning, Henk. The really incredible story that’s played out across the UK over the last six months would have been impossible to have predicted really. I think that we’ve got to try and take it in in different regional considerations.

So, you know, let’s talk about London. London went into lockdown, there was a high demand for a change in space, multigenerational living, a requirement to enjoy a home and garden and home office environment that drove two things. London residents to increase the quality of the footprint of the property that they had. So that’s either to refurbish or to sell up and move on and taking advantage of the stamp duty window that was available certainly in prime and super prime where some of those factors were less important.

What we saw was a near doubling in transaction volume year on year which is just incredible really that’s also been countered by moves outside of London and of course that’s a thing that everybody’s talking about, the best locations etc that, you know, there’s prime country, prime coastal and prime town houses all of them have seen incredible demand over the last six months, in fact 12 months, as London residents look to buy property that met some long term needs.

But what they’ve done is they haven’t necessarily sold the London property. They’ve been reticent and reluctant to do that because they see the market opportunity increasing over the next five years and actually an opportunity to have some capital return.

Also, as markets open up and as the UK opens up, the need to be in London is unclear, you know, will I need it two, three days a week or will I only need it maybe once every, you know, few weeks or maybe once a month, they just don’t know at this point. So there’s been a reticence to release those properties back into the market. That has exasperated the supply and demand dynamic within London as well.

So you’ve got a London market, you’ve got a country market and certainly in those prime country markets there’s been a huge uplift in demand that has surprised and in many aspects shocked agents locally who have seen, you know, huge subscriptions to properties in specific areas. So that continues.

And I think more globally, in terms of the markets outside of the UK, you know, we’ve seen clients who have been looking to release equity out of their properties so that they can fund those lifestyle property purchases which have included buying properties outside of the UK.

So all of those factors together just continue to show that the client sentiment has changed first of all. Buyer behaviour is changing. And, of course, the government activities, the government schemes that have been playing out have also helped support some of those strategies.

HP: Well, let’s talk a little bit about sustainability because that’s an interesting point there. When we look at the macro environment we’ve got historically low interest rates in the UK. We’ve seen these government schemes that have certainly been supporting the market, although some of those start to taper off over the course of the next couple of months. It’ll be interesting to see what sort of change that will have. And you’ve got these supply and demand imbalances.

When you look at those, along perhaps with currencies as well I suppose from an international perspective, but when you start to look at some of those key elements which are important to you in terms of understanding the sustainability of the price increases that we’ve been seeing?

SM: Yeah, OK. Really interesting question to look at different parts of the market. Specifically I think in terms of the broader UK market clearly interest rates are probably the most important factor, being able to have long-term cheaper funding available is key. You know, clearly we’ve seen the government bring in a number of initiatives to help first time buyers get on to the property ladder but we’ve also seen central bank activity that has kept funding costs very low at any level.

So all of that remains really important and what we are absolutely seeing at the moment is a demand but also a response for longer term fixed rate pricing and that’s become very evident in the marketplace where consumers are voting with their feet, looking to lock into longer term funding, five years, seven years, even 10 years.

And really on the basis that stability is key and understanding what your payments look like on a monthly basis over a longer period of time is important especially if you have a two property strategy, one in London and one outside of London.

But also, certainly for our international buyers and our private clients, there’s a view that the upside window is closing and really what I mean by that is that everything seems to spell that there will be a normalisation of the pre-pandemic period and we’ll see central bank rates start to creep up at some point over the next, you know, year or so and that inflationary pressure will continue to drive that along and I think that that is driving a lot of that sentiment to go to longer term fixed rates.

HP: Yeah, that macro environment is quite interesting. We know inflation has printed higher certainly in the short term but we still think that will take some time to filter through to higher interest rates in terms of the UK so perhaps there is still that window of opportunities for buyers.

What we do know is inflation is certainly a hot topic. We’ve been talking about that during the course of today’s podcast so interesting to think about that in terms of what it means for the property market. We know the cost of transportation has been rising, labour, material costs have all been picking up as well. What do you think the knock on effect of that will be in terms of the property market?

SM: Yeah, a really important factor at the moment. It’s impacted a number of factors. So one of the most important is the new-build market, you know, that brings new property, quality property to the marketplace. In prime and super prime we’ve seen a mere 13 transactions in the first six months of this year at above £5 million. That’s compared to 33 last year. A large proportion of that is driven by both shortage of labour and cost of materials. I expect that to continue.

I think if you think about all of the transactions that have taken place over the UK in terms of people moving it is absolutely expected that many of those people will be looking to improve the homes that they move into because clearly new-build properties aren’t coming to market as quickly as they have traditionally. So that puts additional pressure on the cost of labour and materials.

And then lastly we’ve got those that didn’t move but instead are saying, hey, look, we’ve got a really good footprint in terms of the property that we own at the moment. What we’re looking to do is add some space and have an extension, whatever it might be, home office etc. All of that again has then added further pressure to labour and materials.

So certainly, you know, whether I’m talking to agents, whether I’m talking to clients, whether I’m talking to colleagues or friends, everybody is feeling the squeeze of being able to get high-quality materials into their homes and high-quality labour into their homes to help bring that, bring some of those plans together. So I see that as being one of the most important pinch points at the moment.

And I think commentary generally doesn’t see that easing up very quickly because there is, you know, as you’d expect with any kind of building project it’s not something that takes a week or a month, it’s something that, you know, requires planning, requires deviations as it goes through, requires, you know, specific weather factors to be considered, all sorts of things that really delay timelines and as a result I think this time next year we’ll probably still be talking about shortage and cost of labour.

HP: Well, Stephen, thank you for your insight today. We certainly know it’s a topic that’s of great interest to our listeners. We appreciate you keeping us informed.

Let’s move on to consider the outlook for this week. The European Central Bank meeting on Thursday translating the new strategy into action I think will be the focus. The revised forward guidance implies loose for longer. We still think there’s a long way to go before the European Central Bank delivers on its 2% medium term inflation target.

Moreover, the more flexible framework for tolerance and moderate and temporary inflation target overshoots allows the ECB to be persistent and patient. We expect no changes therefore to the very accommodative European Central Bank policy stance at the July meeting.

Turning to the UK, we expect the GFK consumer confidence levels to edge slightly higher in August driven by ongoing normalisation. However, the rapid spread of the Delta variant may pose downside risk for confidence though conversely sports events may have lifted the mood.

Taking into account the signal from the Barclays Spend Trends we believe that retail sales should come in slightly below consensus, -0.3% month on month but still +9.4% year on year. This would be consistent with the high frequency activity data mostly moving sideways since late May.

So with that we’d like to thank you once again for joining us. We will of course be back with our latest instalment next week, but for now may I wish you every success in the trading week ahead.