Markets Weekly podcast - 22 November 2021

Henk Potts (HP): Hello. It’s Monday, 22nd November 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 will then reflect on the progress made during the recent COP26 conference. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead. 

The rally in global equity markets stalled somewhat during the course of last week as rising COVID cases in Europe, inflation fears, and elevated equity valuations infringed upon risk appetite, although solid economic data releases covering household consumption and labour markets, coupled with robust corporate earnings from major US retailers, helped to offset much of the weakness. 

The S&P 500 was actually up over the course of the week. It was up three-tenths of 1%. And, remember, it’s up 25% year to date. 

European stocks were little changed over the course of the week. But analysts lined up to claim the region’s equity markets could outperform their US rivals during the course of next year. This is as European stocks traded at their largest valuation discount to their US peers on record, according to Bloomberg data. 

While equities remain resilient, we did see some foreign exchange reaction to the surge in COVID cases in Europe, as Germany reported record new infections, Austria imposed new restrictions, and the Netherlands and Belgium telling employees to work from home. 

Money flowed into the safe-haven assets, namely the Swiss franc, which hit its strongest level against the euro in more than six years, breaking the 1.05 level during the course of last week.

We anticipate the franc will remain elevated through the first quarter next year, due to safe-haven status, real yield appeal, and political uncertainty ahead of the French election, then start to weaken in the second half of next year as the S&P lags behind other central banks on policy normalisation, leading to wider rate differentials. 

Markets, of course, were eagerly waiting for the latest UK employment inflation data to see if it would provide the missing piece of the hiking puzzle for the Bank of England. When the numbers came in, they didn’t disappoint the hawks. Figures showed that employment strengthened in October, and the labour market was able to absorb a larger number of workers who rolled off the furlough scheme than was expected.

So what did the employment data tell us?  The number of people on payrolls increased by 160,000 in October. Payrolls are now eight-tenths of 1% higher than they were in February 2020. Although some redundant workers may still be on payrolls as they work out their notice, that is thought to be a relatively small number.

London employment, which fell more aggressively than other regions during the course of the pandemic, is catching up, and has now overtaken growth rates of many other regions.

In terms of single month data for September, well, the unemployment rate fell to 3.9%, which is actually slightly below pre-COVID levels, and has fallen for nine months in a row.

If we look at the total hours worked, it also improved, but that was still 2.4% below pre-pandemic levels. Inactivity, as we know, continues to be a problem, and that figure still remains very high, 21.1%.

Particularly amongst the older generation, the plus 50s, remain stubbornly high in terms of inactivity, but there are some signs of progress when it comes to the younger population, where inactivity has been falling. 

Moving on to those inflation figures. Well, October CPI came in stronger than expected, hitting 4.2%. That’s the strongest pace that we’ve seen in a decade, and more than double that 2% target.

The largest contributor was household services, due to the increase in the energy cap, then transport driven by fuel and used car prices. 

UK CPI is now expected to peak at 5.3% in April next year, and then average 4% during the course of 2022.

In terms of the impact, the latest print suggests robust labour market momentum going into the end of the furlough scheme, few signs of the long-term scarring that was once feared. Certainly, if you look at vacancy rates, well, they hit a new record high of 1.17 million.

So I think if we take the labour data, coupled with rising inflation expectations, it suggests the MPC will, indeed, pull the trigger on a rate hike at the December meeting. We’re anticipating a 15 basis point hike, followed by a further 50 basis points in the first half of 2022. 

Moving on to US retail sales, they showed consumer spending has been gathering momentum after a soft patch at the start of the summer. In terms of numbers, headline retail sales rose 1.7% month on month in October. The market was looking for a figure closer to 1.4%, but in fact the 1.7% represents the biggest jump since March. It follows on from strong gains in August and September.

The report shows that household consumption growth is sustainable even without the benefit of stimulus support payments. The outlook for the US consumer we think, remains positive. We’ve seen a remarkable recovery in terms of the US labour market. Unemployment, remember, has fallen from a peak in April 2020 of 14.7% to 4.6% last month. We’ve seen a huge accumulation of excess savings during the course of the pandemic, somewhere around about $2.7 trillion when it comes to US consumers, and we know there’s still strong pent-up demand.

As we look towards 2022, we would expect savings rates to normalise, future consumption to start to pivot away from goods into services, but we’re projecting private consumption growth of above 3% during the course of next year, which we think will be supportive of US growth prospects.   

So that was the global economy and financial markets last week. Also last week, as we know, an extended time COP26 concluded, with 190 countries signing up to the Glasgow Climate Pact. The deal and associated side agreements makes progress towards keeping the 1.5 degree Celsius target of the Paris Agreement alive in principle, but there were varying views of whether the event was successful.  

So here with me today is Damian Payiatakis, our Head of Sustainable and Impact Investing, to discuss the outcomes of the conference, and more importantly, the implications for investors. 

Damian, let’s get started with a summary. My first question to you is what’s the conclusion? Was it successful?

Damian Payiatakis (DP): Morning, Henk. Thanks for having me on today. Interestingly, if I’m reflecting on it a little bit, it reminds me of the proverb of the blind men holding the elephant who each, holding one part and the animal, decided what it was. So, unsurprisingly, activists were disappointed in the outcome, governments declared victory, and corporates played more of an active role and presence than in past years.

I think pragmatists recognise progress, but also express concerns around the lack of enforcement mechanisms for commitments and other challenges that face us ahead. Realistically, like any global summit or event, there’s considerable discussion or posturing, or in the proverbial words of one climate activist, blah, blah, blah. Interestingly though, for many there was more of a palpable sense of urgency around the issue, and, as well, the discussion focused on 1.5 degrees rather than well below 2 degrees, which had been the historical discussion point.

And I think that’s a really significant shift in the discourse, even if it is, quite honestly, much more aspirational. That said, the mantra of keeping 1.5 degrees alive, that many espoused, wasn’t really the most aspiring of rallying cries, and in the end commitments made in Glasgow probably did just about do that.

Pre COP26, the IEA estimated that policies would mean 2.7 degrees of climate warming. And post-COP26 commitments ended up being around 1.8 degrees.

However, we know commitment to policy, to action is definitely a long road. Certainly, the heavy lifting in execution is still to come, with the hopes that the pandemic is being managed downward next year, COP26 gave some momentum for the world being back to focus on avoiding climate breakdown as really the next systemic challenge.

HP: So were there particular agreements or outcomes that you think are important to highlight?

DP: Well, you know, importantly, though it was billed, and arguably is, the most important COP since Paris, it wasn’t set up to have that single, big signature move. This COP was much more getting into the detail, and trying to move forward on multiple fronts.

Perhaps most significantly, fossil fuels were explicitly acknowledged for the first time as a key driver of global warming, and now, while this wasn’t that stronger phrase of phase out from earlier drafts due to late intervention by China and India, the commitment to accelerate efforts to phase down unabated coal power and inefficient fossil fuel subsidies, recognising the need for support for a just transition, is a massive step forward for COP.

As well, progress was made on other areas. Carbon markets, methane emissions, additional funding for adaptation and for deforestation. But clearly there are also areas that fell short. Multiple, you know, additional climate financing for less developed countries, more adaptation finance, compensation of vulnerable nations for loss and damage.

You know, I think perhaps most importantly, negotiators agreed to bring forward the date to revisit and strengthen the 2030 commitments, the NDCs, those Nationally Determined Contributions, from 2025 to next year. And that really means that countries will need to demonstrate progress, and further ratchet up those commitments.

And I think it’s, in reality, it’s only in practice whether progress is made, and commitments translate into those actions. So if I think about it, the Bank of England announced that it will no longer buy bonds from companies that make money from coal mining, and firms that need to satisfy some climate-related eligibility criteria to be purchased. You know, that’s one example where we see the real impact of COP.

HP: Mark Carney, former Governor of the Bank of England and current UK Special Envoy for Climate Action and Finance, has previously warned of a “Minsky moment” for climate. To explain this, it refers to a collapse in securities prices due to a sudden panic at a future date, as risks are allowed to build up. Will we see one of those moments for climate-related assets play out?

DP: Well, you know, contrary to what many of the anti-climate perspectives suggest, you know, most of those involved in the area are really trying to avoid the Minsky moment. You know, managing the transition in an accelerated way that is just and fair to everyone. You know, generating a crash in asset values, and the associated repercussions of that, is not a situation any constructive actor wants to be, in terms of planning to solve this problem.

You know, as you heard about multiple commitments from investors and the financial sector, I think it takes pressure off of policymakers, who are the ones setting the rules. And I’d agree, at present, that, you know, the view is too much expectation is being heaped on the financial sector to solve this problem. You know, at the moment, I’m not confident we’re seeing enough action in the short term.

And I don’t want to sound alarmist, but the scenario of a disorderly transition, and that’s one in which we fail to act swiftly enough to deal with the crisis now, and then have to move later on to make up for lost time, looks more likely than ever, and for investors this means preparing earlier in relation to climate change for their portfolios.

HP: So let’s get a little bit more practical, Damian. What should investors be doing now?

DP: In reality, this is about getting your portfolio climate-ready. If you’re not sure how to do that, I wrote a three-part series on how to do that, how to set an ambition, how to take action in your portfolio, how to measure and manage impact. And, however, the question really boils down simply, for investors, to be looking at both sides of their portfolio, both risks and opportunities.

So the way that we think about it, you know, a central pillar of a climate-ready portfolio is to understand the risks, and those are both physical risks and transition risks to current or potential holdings, right?

So we can protect value in a portfolio through, for example, more detailed scrutiny of environmental factors, be that ESG analysis, we can measure and cut the portfolio’s carbon footprint, or we can reduce exposure to assets that are at risk from climate change so they’re not stranded.

However, you know, protecting your portfolio doesn’t necessarily protect the planet. Fundamentally, the global ambition is to decarbonise the economy and human activity, and this means a real realignment of economic activity. This is the building back better that everybody has been talking about. And, in turn, we need more capital to catalyse and make the changes that are required, which means new innovations, existing ones to scale, and novel solutions to be invented.

And I think this is really where the opportunity side of climate change comes in for investors. It’s really one of the biggest investment themes of our lifetimes, and investors who can spot opportunities are going to be rewarded for that even, quite frankly, if nothing has fundamentally changed with COP26.

I think those who appreciate that opportunity should feel the conviction, you know, the level of belief in that view to be on the stronger side of that trade going forward.

HP: So, Damian, if investors want to learn more, where would they go next?

DP: You know, ultimately COP provides important frameworks and leading indicators for investors to be reviewing. And we did that in our 2022 outlook. We outlined some of the sector opportunities across three themes. First, addressing energy needs and climate change. Secondly, reducing our environmental footprint. And third, conserving biodiversity and the natural environment.

So we can look there, but then also for clients, they can listen to further discussion of COP26 and climate opportunities at our year-end outlook on Wednesday, where I’ll be joined by our Barclays Investment Bank’s Head of Sustainable and Thematic Investing Hiral Patel, our Head of Fundamental Research Marie Freier, and our own Head of Sustainable Portfolio Management Mike Topley.

It should be enlightened discussion, and I’ll ask their views on portfolio positioning post COP26.

HP: Well, thank you, Damian, for your insight today. It’s clear that climate change will be an important driver for both policy and, indeed, investment returns over the course of the next few years, and is truly becoming an integral part of the investment process. 

Moving on to this week, where the focus will be on the United States, when we get the minutes of the FOMC meeting, the central bank’s latest deliberations. We look for the minutes to place a heavy emphasis on why the economy has achieved substantial further progress, and as a result justified the decision to announce the tapering of the asset-purchase programme. We also expect the minutes to be a full discussion about the uncertainties, with respect to the development of the labour market, and with respect to the outlook for inflation.

Markets will also be expecting an announcement from President Biden regarding his pick for Fed chair. It’s reportedly developed into a two-horse race, between incumbent Jerome Powell and Fed Board Governor Lael Brainard. Brainard is perhaps seen as being slightly more dovish than the current chair, but regardless of the decision, we’re unlikely to see a major shift in policy expectations, but certainly one that’s likely to grab some headlines.

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