Markets Weekly podcast - 8 November 2021

Julien Lafargue (JL): Welcome to a new edition of Barclays Market Weekly podcast. My name is Julien Lafargue and I’m the Chief Market Strategist for Barclays Private Bank, and I will be your host today.

As usual, we will first go through the events that defined last week in the markets before moving on to our guest segment. This week I’m very pleased to be joined by Damian Payiatakis, the Head of Sustainable and Impact Investing here at Barclays Private Bank, to take stock of the latest COP26 announcement.

But before that let’s take a closer look at last week’s events. Last week was clearly all about central banks, with both the Fed and the BoE providing updates on their monetary policies.

As widely expected, the Fed announced the beginning of its tapering process. The only unknown was really the pace of the process, and the central bank confirmed that it will reduce its monthly purchases by $15 billion a month. At this pace, the Fed is expected to stop injecting new liquidity in the market by the middle of next year.

The only real surprise in the Fed’s announcement came from its commitment that it’s prepared to adjust the pace of purchases, if warranted, by changes in the economic outlook.

While $15 billion amount was previously seen as a ceiling, this sentence would suggest that the Fed may be willing to accelerate this tightening if inflation were to accelerate further.

On the topic of inflation, the Fed continues to see it as transitory although risks are clearly skewed to the upside. Finally, Jerome Powell, who by the way is still interviewing for his own job, made it clear that tapering and rate hikes don’t go hand in hand, and the latter could be subject to a much more stringent set of criteria, especially when it comes to the job market recovery.

So overall, Jay Powell and the entire FOMC managed to navigate tapering without creating any tension this time around.

The market did remove some of their most hawkish bets, leaving about one rate hike being priced in for next year, which is in line with our best case scenario.

Investors’ focus will now gradually move on to macroeconomic data, in particular inflation and jobs. On the latter, the nonfarm payroll reported on Friday suggested the recovery is ongoing, although we are still about four million jobs short of pre-pandemic levels. And while the Fed would like to get all these people back into the workforce, they may struggle.

Indeed, the participation rate remained fairly subdued, likely constrained by a range of factors including the fact that many Americans may have decided to retire early. In a paper recently published by the St Louis Fed, it is estimated that as much as three million Americans have decided to retire early, possibly taking advantage of the recent surge in equity markets.

Now the other key news came from the Bank of England. While the Fed did its best to stick to the market script, the BoE surprised many people by deciding not to hike interest rates. While this may just be delaying the inevitable, this decision sent dovish shockwaves through markets, pushing yields lower and equities higher led by growth stocks.

Well, like its peer, the central bank expects inflation to be transitory. As we discussed in this very podcast last week, the UK is facing many more issues which make its life a lot more difficult. And so the BoE wanted to have a bit more time to assess the job market recovery as furlough schemes come to an end.

We still expect the BoE to hike next month, but the outlook for 2022 is increasingly uncertain, and two hikes in the first half of next year would really be a maximum in our opinion, especially if the bank itself forecasts inflation recedes in the back end of 2022.

Now aside from central bank, the other key piece of news was earnings season and the end of it. The third-quarter earnings season is gradually coming to an end, and it looks like earnings growth in the US will settle at around 41% year over year. This is about 11 percentage points higher than initially expected by the consensus, and all of this is very solid. As we expected, the surprise factor is back to a more normalised level, and we expect this trend to continue with earnings growth likely to decelerate further into next year.

There is obviously plenty more to discuss about the market but we will cover these in greater detail in our 2022 outlook which will be released next week.

Before that we wanted to touch on the other major event taking place at the moment, the COP26. This is the 26th conference of bodies, when the 196 countries, or bodies, that are seen at the climate change convention have met to discuss how to mitigate and adapt to global warming to prevent climate breakdown.

And so I’m very pleased to be joined by Damian Payiatakis, our Head of Sustainable Impact Investing, to debrief the first week and the implications for investors.

So let’s keep the background of COP and go right into the detail. Many countries have come out with new or revised net zero commitments. And, Damian, can you tell us about those and whether we’re on track for the 1.5 or 2-degree target of Paris?

Damian Payiatakis (DP): Thanks, Julien, and a real pleasure to be here to talk about this.

Clients can think of COP a bit like an annual review and a strategy planning session for how we address climate change. And one of the key mechanisms are those commitments that are making the nationally-determined contributions of the NDCs.

And so what happens is countries must regularly increase their proposed emissions cuts, the so-called “ratcheting up” process. And at this year’s COP26, all the participating countries have been asked to submit emissions-reduction targets for 2030 that will set them on the path to reach net zero by whatever their commitment is.

And so before COP26, different analysis showed the existing countries’ pledges, where we’d get the world to, and really what the idea was, or the expectation was, that the world will be on track for just under a three-degree rise in temperature, very clearly not that 1.5 or 2-degree target that Paris set.

Now the good news is following some recent announcements, and some rapid estimates that were shared on Thursday from the IEA, they calculated that if the new NDC promises that have been made and are kept, that we’ll go to a 1.8-degree rise in global temperatures. And we’d still need to see more detailed analysis, but a one-degree difference, let’s say, is really considerable in terms of how much that has come down.

And while that is good news, it’s still not enough. You know, analysis of the difference between a 1.5 degree and a two-degree scenarios are really significant in terms of their physical effects and the weather conditions and life on the planet.

And, moreover, there’s a real difference between an NDC, which is a pledge, and a policy that government puts in place. And then after the government puts a policy in place, what the execution actually looks like.

So it may be like I commit to living a healthier lifestyle but have I signed up to the gym or have I bought the exercise bike? Have I decided how many times I’m going to work out? That’s the policy coming into practice.

And then obviously am I going to the gym or am I working out, you know, or is the bike the clothes horse sitting on the side of the room? And that’s the execution question I think that still exists for many in the field to say these commitments are great, but ultimately the question is are they going to be seen through on a policy, on a non-execution basis?

JL: Great. So what do net zero commitments mean for investors?

DP: So realistically a net zero commitment doesn’t immediately inform investors’ decisions, but they’re signals and really signs to pick up.

So investors should be observing the commitments that are made as an idea of the direction of travel, and also the speed and the severity of the changes that are going to be needed.

I’ve talked in the past about inevitable policy risk, which is simply the idea that if you’ve committed to these targets you have to implement policies to make them happen. And the commitments are going to drive actions at the industry and at the sector level, which is where countries are looking to shift their emissions contributions.

And also the longer you wait, the more challenging those cuts or changes will have to be. The bigger and faster changes will have to be made to hit the targets that people are committing to. So we think investors should be looking at the policies and plans as well as the interim targets.

And I’d refer people back to the article we wrote actually in August, about Europe’s Fit for 55 legislative agenda as a good example of how Europe has taken the high level commitments and started to drive a legislation agenda around it. And we’ll obviously have to see in the US, who’s made a 2050 net zero commitment, but the Biden green deal obviously is still stalled in the legislative process.

Interestingly, if we look at this week, coming back to COP, this last week India announced a 2070 net zero target. Now, that may not be the 2050 target that many countries have made, or that global scientists believe we need to hit, but it was backed up by a few notable plans that I think make an example where it’s interesting for investors.

So, for example, it included a renewables goal for energy production to be at 500 gigawatts by 2030. And at that point renewables would be half of India's energy supply, you know, and that is a massive shift in terms of where they are, from where they are today.

And more broadly, they’re committing to cut carbon dioxide emissions by one billion tonnes from the BAU by 2030. So you start to looking further in these areas, you start to see where they become relevant for investments. And as investors that’s what we’re really looking for, the tangible plans and the execution to go along with the commitments.

JL: Well, COP is not just about countries, but international agreements, deals, and companies’ efforts. So what have been some of the outcomes there?

DP: There have been lots of micro deals we could say over the last week, but let me highlight two small, but really important ones - one around methane and the other around financial systems.

So the EU and the US launched the Global Methane Pledge, which aims to limit methane emissions by 30% compared to 2020 levels. And so far over 100 countries have signed up to the initiative, though China, Russia and India, which combined generate about a third of methane emissions, haven’t yet joined or have yet joined.

We generally talk about CO2 or carbon dioxide, but it’s really all greenhouse gases that contribute to global warming. Methane actually traps more than 80 times the heat that the same amount of carbon dioxide does in the first sort of two decades in the atmosphere. But it also rapidly degrades in the atmosphere as well, and this means if we can stop the release of methane, we can have an almost immediate cooling effect on the earth’s temperature.

So this agreement is important because it commits countries to address their methane emissions, primarily from oil and gas but also other sources such as agriculture or waste.

Now if we look back at the US for a second, there’s work on regulation that will levy a methane fee on oil and gas producers, and by some estimates it could be as much as $1,500 per tonne that is released. Now, if you’re looking at it, that’s either a huge cost or a burden on those businesses, or an entrepreneur, for entrepreneurs. With carbon capture, usage and storage technology that’s a massive opportunity that makes their products more viable, you know, commercially.

And that’s a good example, I think, of the first one where you’re seeing these micro deals that are being done that have investment implications around them.

The second one is GFANZ, or the Glasgow Financial Alliance for Net Zero, which sounds like it should it should be a rap band instead of a global commitment.

But what that really talks about is 450 firms, banks and asset managers primarily, who represent about $130 trillion of assets, are signatories to greening the financial system. And that’s almost double the amount, the $70 trillion that when GFANZ was launched just back in April of this year. And that means that 40%, that 130 trillion of assets, 40% of the world’s financial assets now have pledged to meet the goals set out in the Paris climate agreement.

Now, you could argue many were already on track. We in Barclays have our own 2050 net zero commitment that was made, you know, over 18 months ago, but it really enshrines and sets out the framework and the reporting to deliver it, again back to the consistency and driving this together.

And I think what that means collectively is, therefore, financing for carbon intensive businesses is going to be a lot more expensive. And as these firms don’t want to have stranded assets or reputational risk of holding the heaviest emitters, they’re going to be doing more to either help them transition or to stop financing them.

And again, from an investor standpoint you’re looking at that and going, well, what are the stranded asset risks or the policy risks that are going to be coming out?

And it also, obviously, on the other side suggests that companies who are providing solutions, the green finance solutions, are going to be more attractive to banks and asset managers. And as investors obviously these are the things that we’re looking for that are material in their portfolios.

JL: So it sounds like this is all going very well.

DP: Well, no, I wish it was. There are definitely gaps. It’s interesting actually after the G20 summit, which is a precursor to COP26, the UN Secretary-General Antonio Guterres on Twitter wrote: “I leave Rome with my hopes unfulfilled, but at least they’re not buried.” And after the first week it kind of feels a bit like he could have reposted that tweet in terms of where we are.

Obviously for many people, and Friday being the day where you had the most vocal youngest generation being active, there’s clearly not enough being done from their perspective, but there’s a couple of other issues I think at the end of the first week that we’re looking at.

The first is the commitment of wealthier countries to finance $100 billion per year for poorer nations to pay for climate-change mitigation and adaptation. And this is to acknowledge the fact that wealthier nations have benefited economically from being able to pollute while they’ve grown their economies, and that less developed nations should not be disadvantaged or have the burden of more costly technologies being brought in.

So part of the funding is really to help them accelerate that transition or leapfrog, you know, historically we’ve gone from wood to coal, from coal to oil and gas, and now oil and gas to renewables. And so for investors what does this mean? We’re trying to say, well, let’s look at how does this funding help to support that leap to renewables, and where does it support in derisk? Renewables and energy generation, definitely something to watch.

And, moreover, where, given geography obviously, these countries, the less developed countries, who are or will be the most affected in terms of climate breakdown. So the other parts of the financing around where mitigation of climate effects from an agriculture perspective or from a life perspective, or even from a, you know, there are cities that are literally sinking, and thinking about how do you relocate people in relation to that.

So again, where the solutions to some of these problems in less developed countries can actually accelerate is an interesting one. But more needs to be done to get the developed world to commit and provide the funding to that.

The other big agenda item is the rules for the global carbon market and those are still under discussion. Getting a way for countries to price the cost of polluting greenhouse gases, and explicitly accounting or charging for it, would be a step change in the dynamics of climate change, and I don’t think we’re likely to have a single global carbon price at the end of this. But having a mechanism to set and to manage, as well as to do, what to do with the revenue that’s generated from this is really important.

But the sticking point, at the simplest, is that developing countries would like, where imports are charged a carbon border tax adjustment, to receive some of that funding. And so the developed world, particularly the EU, is resisting. And there’s another week, so certainly we hope to see more progress, and also the influencer Ben Caldecott, who joined us at an April event, laid some of this out and we featured him a few weeks ago in a podcast to talk a little bit more about this.

JL:  Right. Maybe any final thoughts and views for week number two?

DP: Yeah, absolutely. I think in the immortal words of Greta Thunberg, there’s a concern that all of this is blah blah blah. But unlike COP21 10 years ago, COP26 isn’t about signing a major accord. This is really about how to get the Paris Agreement to be delivered. So hopefully there’ll be more smaller tactical announcements and agreements.

And really for investors, though, these are the inflection points that we’re going to continue to be observing and considering. And this is ultimately where your portfolio, when you’re looking at it from a climate risk and spotting attractive sectors and opportunities, comes to life.

So let me just close with a small plug for our year-end outlook. The article that I wrote highlights across three themes where we see, you know, bigger climate opportunities, and obviously at our upcoming 24th November year-end outlook session, the panel discussion will focus on this topic as well.

JL: Thank you very much, Damian. Clearly a lot to think about when it comes to climate change, and this is a topic that we will also cover in our upcoming 2022 outlook.

But before that, we have another busy week ahead of us with US inflation data due on Wednesday, a possible announcement as to whether Jay Powell will keep his job at the Fed and a few additional earnings reports.

But with that, let me conclude by wishing you all the best for the trading week ahead.