Markets Weekly podcast – 28 March 2022

Henk Potts (HP): Hello. It’s Monday, 28^th March 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 consider the impact of the upcoming presidential election in France, and what effect that could have in terms of markets. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Equity markets continued to rebound last week, and the sell-off in government bonds deepened as investors reacted to the intensification of the hawkish tone being sung by the Federal Reserve. At a speech to the National Association for Business Economics, Fed chair Jerome Powell doubled down on the need to tighten policy quickly, warning that upward pressure on prices from the invasion of Ukraine comes at a time of already too high inflation. He went on to say if the Committee concluded that it was appropriate to move more aggressively by raising rates by more than 25 basis points, at a meeting or meetings, they will do so, and stated that the Fed was willing to raise rates above the neutral rate if necessary. The neutral rate, to remind you, is a policy level that neither stimulates nor slows activity.

The comments squarely put a 50 basis point hike on the table for the May meeting. Last week, traders increased the probability of a half-point increase to around 64%. That was up from just over 50% the previous week, although, on balance, we still have a quarter pencilled in, but it could, indeed, be a very close call. As a result, the rout in bond markets extended, Treasuries looked set to register their worst quarterly performance since the early 1970s. The yield on the 10-year Treasury rose above 2.5% on Friday, that was for the first time since May 2019, and the yield on the 2-year saw its biggest weekly gain since 2009.

The rebound in equity markets has been fuelled by a range of factors, including hopes of peace talks, cheaper valuations, and robust earnings expectations. Equities are also seen as a hedge against inflation, and stocks are also benefiting from the money flowing out of bonds.

On Wall Street, stocks registered solid gains. The S&P 500 was up 1.8%, with financials leading the way. The STOXX 600, in Europe, was flat. The British Chancellor, as we know, was set a difficult task as he delivered the Spring Statement against a backdrop of the highest inflation in 30 years, the biggest squeeze on living standards in a generation, and the aggressive downgrade to UK growth forecasts. However, he did find some fiscal headroom to cut taxes for some workers and reduced the impact of surging energy bills.

In terms of the forecast, well, the Office of Budget Responsibility signalled tough times ahead. 2022 growth was cut from 6% to 3.8%. Real GDP looks set to slow further in 2023, to 1.8%. They forecast inflation will average 7.4% during the course of this year, and peak at 8.7% in the fourth quarter. Debt interest costs are forecast to hit a record £83 billion this fiscal year.

On the positive side, unemployment is expected to be lower. Consumption, they said, would be supported by a greater drawdown of savings that have been built up during the course of the pandemic. Business investment is set to grow by 10%.

So, in summary, the Chancellor’s tax changes went slightly further than expected, which will ease some of the pain, but the tax burden is rising to its highest level in decades, and there’s no getting away from the pressure on UK living standards that is to come, with real disposable incomes forecast to decline by 2.2% during the course of this year, which would be the largest fall since ONS records began back in 1956.

Moving on to European data, which showed that price pressures are continuing to build, German producer prices rose to a record high in February, hitting 26% year on year. Economists watch factory-gate costs very closely. They’re seen as a leading indicator for consumer prices. Last month’s surge was the largest since records began back in the 1940s, while energy prices were the main driver, up 68% year on year. Even when the energy component is stripped out, producer prices would still be up 12.4%. Perhaps even more concerning, is that these increases do not reflect the impact of the war in Ukraine.

The European PMI has confirmed the inflationary pressures, with both input and output prices rising. The surveys also highlighted that manufacturing is suffering from a significant deterioration in foreign demand, new supply bottlenecks, and weakening expectations. Services is also expected to come under pressure, given consumer confidence in March fell close to the pandemic low.

In terms of markets, well, gold rose 1.3% last week, trading at around $1,954 an ounce. It’s up around about 6% year to date, as the precious metal continues to benefit from demand as a safe-haven asset and as a hedge against inflation.

In terms of demand, investors have increasingly been putting their money into exchange traded funds, so if you look at the total gold held by ETFs, it was up around 7.7% year to date, to 105 million ounces, that’s the highest level since February 2021. Bar and coin investment remains robust, central bank purchases remain supportive. Furthermore, jewellery demand has been rising, especially in the likes of China and India, helped by the economic recovery. Technology has also been demanding more gold as well, although it is worth noting, of course, the stronger US dollar and rising bond yields are both headwinds for golds.

In terms of gold’s place within a portfolio, we think gold can, indeed, be used as a diversification tool, but won’t drive those long-term returns. Gold is probably more likely to preserve wealth during periods of turbulence rather than grow portfolios over time. If you look at our capital market assumptions, it shows allocation should still be in the low single-digit range.

So that was the global economy and financial markets during the course of last week. Next month French voters will be asked to choose a candidate they feel is best to serve to govern the country over the course of the next five years. The election, as we know, comes at an important juncture, as the world continues to be shaken by Russia’s invasion of Ukraine and the fallout from the global pandemic.

I’m pleased to say that we’re joined by Philippe Gudin, he’s managing director and senior economist with Barclays Investment Bank, to preview the election and discuss the possible economic ramifications.

Philippe, great to have you with us today. The first round, as we know, is less than two weeks away. What do opinion polls tell us about the most likely outcome?

Philippe Gudin (PG):  Good morning. The election will take place, as you say, in two weeks. It’s a two-round voting system, bear that in mind. We have 12 candidates who are running and the two with the most votes in the first round will qualify for the runoff two weeks later.

So, opinion polls have been very volatile over the last month. The only candidate who remained relatively stable in the opinion polls for the first round is Emmanuel Macron, the outgoing president, who has been consistently run first, well above his contenders. He currently stands between 28% and 30%.

Behind him, four candidates could be in a position to qualify with more than 10%, but recently, Marine le Pen, the far-right candidate from Rassemblement National has taken the lead over the other three, although far-left candidate Mélenchon is also on an upward trend, but still lots of people are undecided and voting intentions could change again. Macron seems to be the one with the most solid support, followed by Marine Le Pen, according to the poll by Ipsos which is testing the solidity of the vote.

By contrast, Valérie Pécresse, the centre-right candidate, seems to be the most fragile. For the second round, Macron is leading against all potential contenders, but the second round is another campaign, and opinion could change once voters know who the two remaining candidates will be.

Polls suggest that Emmanuel Macron’s lead would be much smaller against Marine Le Pen than five years ago, when he received 67% of the vote. Today, according to polls, he would be between 54% and 58%, but he seems to be in a good position to win re-election though. He would be elected even more comfortably should he face the other far-right candidate, Zemmour, or the far-left candidate, Mélenchon, or the centre-right candidate, Pécresse, with about 65% in all cases.

HP: Well, you mentioned the war in Ukraine. How has the invasion impacted the campaign? Could it influence the choice that voters are making?

PG: Actually, all surveys confirm that the war has definitely influenced the campaign, firstly because it has prevented President Macron from entering the race until very late. He officially entered the race only two weeks ago, while other candidates had been campaigning for a month. Secondly, because a rally around the flag boosted his popularity, and his support jumped from around 24% before the war to more than 30% after he announced his candidacy. The poll by Ipsos shows that the war in Ukraine is the theme that dominates for voters, together with the question of purchasing power.

The survey also shows that voters think that the war will be one of the factors that will influence their choice. This may explain the bad performance of Valérie Pécresse and the boost to Emmanuel Macron over the last two or three weeks. However, and surprisingly, Marine Le Pen, who has long been a supporter of Russian President Putin, does not seem to suffer from that, unlike the other far-right candidate Éric Zemmour, who has lost lots of support over the last month.

More recently, the rally around the flag effect has receded somewhat and national themes are back in the frontline, in particular the question of purchasing power in the context of booming energy prices.

Macron has also possibly lost support after he presented his detailed manifesto with two measures which are not very popular, one which is a pension reform and the other one is the reform of the benefit which is called Active Solidarity Income, for which Macron would like to see a counterpart in terms of community work or training. But, nevertheless, the war is definitely dominating the campaign.

HP: So what’s next once the president is elected? Could he or she struggle to get an absolute majority in parliament come June?

PG: Yes, you’re right. There will be a parliamentary election in June, which is very important, but once elected, the president will appoint a prime minister and a temporary government, and then the campaign for the parliamentary election will start. And definitely the campaign will be influenced by the result of the presidential election, not only the results about who is elected but the result of the first round as well, because the balance of power in the next government will depend on how the different candidates, which will be the first one and will be eliminated, will take position for the second round.

Traditionally, the political landscape in France was divided between the centre right and the centre left, and both were rejecting any possible alliance with the representative of the far right. Things are a bit different now, and this election may well be the final stage of the reshuffling of the political landscape, which would see, now, an opposition between the progressist liberals and pro-Europeans, on the one hand, and the conservative anti-liberals and eurosceptics on the other hand, which would confirm the collapse of the two traditional parties, the Socialist Party and the centre-right Gaullist parties.

If he’s re-elected against Le Pen, Macron will naturally try to rally the moderate part of the centre right, who supported Valérie Pécresse, and he will try to form a very large coalition, which would include the centre left, possibly some part of the Ecologist Party, the Liberals, and the centre-right politicians, with a sort of large majority supporting his new government. And the opposition will consist of the unification of most conservatives of La République and the far right, which consists of the National Front and the new party of Éric Zemmour, which is called Reconquête.

HP: Philippe, will the result of the election have significant implications for Europe?

PG: Oh, yes, of course it will. As you know, Macron has been a major supporter of more European integration. If he’s re-elected, he will continue to push his agenda for more EU integration, more EU autonomy, and more EU sovereignty. He’s been the main architect of the EU recovery forum, the so-called next generation EU forum, which is worth €800 billion to be spent over five years and financed by joint borrowing by the EU.

He’s been able to convince former Chancellor Angela Merkel to accept this idea to jointly borrow in financial markets at the EU level to finance the plan. He has also pushed, since his election in 2017, for a common defence policy which has become a priority with the current international environment. And, as France took over the EU presidency in January, he laid down a very ambitious agenda for a more independent and more sovereign Europe, an agenda which has also found some support with the consequences of the war.

So if he’s re-elected, he will push further until the end of the French presidency, and even beyond, to continue this process of EU integration. Conversely, if Le Pen’s elected that would be a complete U-turn in French positions, and that would probably be very bad news for European integration, which would become a lot more difficult.

It’s very unlikely, but if it was Pécresse, the centre-right candidate, it’s not clear yet what her European positions would be and it would depend a lot on how she would form a majority. But again, the probability of her to be elected currently seems to be very low.

HP: So let’s finally think about life after the election. What will be the main challenges for the next president and the next government, given the current economic outlook?

PG: The war in Ukraine came at a time when the French economy was recovering after the winter’s Omicron wave, which eventually had little consequences actually for France. Business surveys were suggesting an improving business outlook and in industry supply bottlenecks were starting to ease, and despite higher inflation, we were expecting robust growth for the rest of the year. The French economy has performed quite well since the recovery after COVID, but the outlook has dramatically deteriorated with the war. There are four channels through which the economy is going to be impacted.

First is paucity of energy and raw materials, which feeds another inflation surge with adverse consequences for household income and company balance sheets. Second, global trade, which is slowing as a result of sanctions, capacity destruction, and some new supply-chain disruptions. Third, the financial channel, with bank exposure to Russia and falling financial markets. And fourth, a confidence channel which is difficult to measure, but which impacts household savings behaviour and companies’ investment plans.

So although it’s not our baseline, a recession is not completely ruled out, and so the next government will have to address this issue. The actual government has already started to deploy some emergency measures to mitigate the impact of higher inflation, especially for modest households, but also for companies. There has been a resumption of the plans which had been deployed during the COVID crisis to try to mitigate the impact on companies’ balance sheets and on the labour market, but more will have to be decided after the election, together with a resumption of reforms that are very important for the agenda of President Macron if he’s re-elected.

So that would be definitely a very busy agenda, and at the same time the next government will also have to restore the sustainability of public finance, which has been undermined considerably during this crisis with a significant increase in public debt, which was necessary to avoid a deeper recession, but which is now a major challenge for the future.

HP: Well, thank you, Philippe, for your insight today. We will, of course, monitor the developments very carefully as we head towards election day on Sunday, the 10^th of April. Moving on to the week ahead, where the big number, of course, comes on Friday as we get the latest US employment report. We anticipate the March figure to continue to demonstrate the remarkable recovery in the US labour market. We forecast nonfarm payrolls to rise by 550,000, which would be down on the 678,000 registered in February, but would be in line with the 582,000 average that we’ve seen over the course of the past six months. We look for wages to reaccelerate. We think they’ll be up four-tenths of 1% month-on-month, or 5.5% year on year, and we anticipate there’ll be a further improvement in the participation rate, and the unemployment rate will hold steady at 3.8% for a second consecutive month.

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.