Markets Weekly podcast - 7 November 2022

Henk Potts (HP): Hello. It’s Monday, 7th 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 with 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 preview the COP27 conference. And, finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.  

Pledges of an extended rate-hiking cycle in the United States and forecasts of a prolonged recession in the UK from the Bank of England dampened investor sentiment during the course of last week, although steady corporate earnings and the earlier suggestion that US labour markets are starting to cool helped to limit some of the losses. 

The S&P 500 fell 3.3% during the course of last week, although it was a brighter picture in Europe and in Asia. The STOXX 600, in Europe, was up 1.5% over the course of the week. Asian stocks rallied on rumours that Chinese COVID rules will finally be eased in early next year, including the relaxation of border controls. The lack of a Fed pivot pushed Treasury yields higher. The policy sensitive two-year yield broke 4.7%, and closed at its highest level in 15 years. 

Speaking of the Federal Reserve, as we know, they raised rates by 75 basis points for the fourth consecutive meeting, pushing the benchmark up to the 3.75-4% range. At the press conference, chair Jerome Powell warned that the central bank still had some ground to cover with interest rates before they get to the level that they consider sufficiently restrictive. Furthermore, he stated, it’s very premature to be thinking about pausing. 

Our new call is that we’ll see a slightly longer, but less intense, finish to the hiking cycle. So, we expect the Federal Reserve to raise rates by a further 50 basis points in December, another half of 1% in February, and a final 25 basis points in March. This suggests the terminal point for the fed funds rate for this cycle will be 5-5.25% in the first quarter of next year. 

As we know, the Bank of England also raised rates by 75 basis points, its biggest increase in more than three decades, taking the base rate up to 3%, the highest in 14 years. However, the vote, the guidance, the accompanying forecast offered a more dovish tone than was expected. 

In terms of that vote breakdown, well, seven members voted for 75 basis points, one for 50 and one for just 25. In terms of the guidance, they said terminal rates will likely be lower than currently priced by markets. 

In terms of growth, it said it was a very challenging outlook as the cost-of-living crisis continues to play out. Its forecast now shows the UK economy is in recession, and sees GDP falling for eight consecutive quarters, taking us all the way out until mid-2024, with unemployment rising to 6.5%. 

In terms of inflation, they said it would disappear over time. They now see inflation peaking at 10.9% in the coming months, but then falling down to zero by the time that we get to 2025. 

Put that all together, what does it mean in terms of the outlook for rates? Well, for us the statement adds to the evidence we are, indeed, coming close to the end of the UK hiking cycle. We do, however, see one further 50 basis point increase in December, putting the terminal rate at 3.5%. 

So, that was the global economy and financial markets last week. In order to discuss the United Nations climate change conference, COP27, which, as we know, is taking place over the course of the next 10 days and will be attended by an estimated 30,000 delegates, I’m pleased to be joined by Damian Payiatakis, Head of Sustainable and Impact Investment for Barclays Private Bank.  

Damian, great to have you with us today. Why don’t you start off by reminding our listeners about the role that COP27 plays in the broader framework of global political and climate change discussions. 

Damian Payiatakis (DP): Thanks, Henk. Well, OK, let’s rewind then. In 1992 nearly every nation signed the UN Framework Weather Convention on climate change. And then since 1995, the countries that have ratified this convention, now about 197, have held a Conference of Parties, or a COP.  

More recently, in 2015, the party signed the Paris Agreement, which covers climate-change mitigation, adaptation, and financing, and its primary goal is to reduce global greenhouse gas emissions, really to limit global warming to well below two degrees, and preferably to 1.5 degrees Celsius. So, the aim of these roughly annual conferences, or COPs, is to meet, evaluate progress, and then negotiate new agreements to reach those goals. 

HP: So, this will be the 27th meeting being held around saving the planet from climate change. Where are we at with respect to that ambition? 

DP: Not well. I mean after rebounding from the pandemic, greenhouse gas emissions are growing again at record levels and we’re already seeing the initial physical effects of climate change. You know, the past eight years are the hottest ever on record. Everyone is seeing, and actually starting to experience around the world, the extreme weather being more severe and more frequent. 

We’ve got floods in Pakistan, cyclones battering southern Africa, Hurricane Ian wreaked havoc on Cuba and Florida. At the same time, you’ve got exceptional heat waves and droughts. China endured its longest heatwave on record, the Horn of Africa the longest drought in decades. I mean, even the UK passed 40 degrees Celsius for the first time, and we saw rivers in Europe fall to critically low levels. 

And this is bleak, right? And this is just with a 1.15-degree temperature rise that’s already taken place. So, if we simplistically add up the current policies in place from all the different countries, we’ll get a 2.8-degree temperature rise and, if we’re generous, and we look at the pledges, that brings that back down to about 2.4 to 2.6 degrees of a temperature rise. 

So, our target, our 1.5-degrees target, is still a full degree below where we need to be at the moment. And, at the end of October, just a couple of weeks ago, the UN environmental programme put out a report, the Emissions Gap Report, that stated that there was no credible path to that 1.5-degree temperature rise in place today. 

Now, before that sounds too hopeless, it’s not to say that it’s impossible, it’s just there isn’t a current path. And this is why COP27 is really being labelled as an implementation COP, which is aiming to turn existing and past commitments into tangible plans and actions. 

HP: Given the extensive economic geopolitical pressures that we see around the world, do we really need this conference or is it just, as Greta would say, more blah, blah, blah? So, my question is, does it really matter? 

DP: Yeah, clearly there are multiple global issues and crises occurring simultaneously. These are interconnecting and reinforcing issues. You can see the relationship between COVID and inflation, supply chains, the Russian/Ukraine war energy issues. And they all actually have relationships with social and environmental issues.  

I think, if we look closely, we can see how energy costs and security, the cost-of-living issues, and the transition to a low-carbon economy all fit together, which is something we wrote about over the summer, in terms of governmental action around these. 

But, I think the important thing is not to look at it as, let’s say, energy transition versus energy security, but really, in some ways, how energy transition can improve energy security, which is obviously the point of COP. And, while I think she has a point in terms of the output or outcome relative to the attendees and the discussions, this is really our best bet to address these issues. 

HP: OK, Damian, let’s get into the real detail of this. What’s on the agenda, what’s the big focus for this year, and what should investors be looking for? 

DP: As I noted, this is being billed as the implementation COP. As well, it’s important to know this has, given the Egyptian’s presidency, it’s also being called as the African COP. In reality, it’s probably a bit broader than just Africa. We should really be expecting developing nations to be applying more pressure to the Global North to take action and to provide financing. 

So, historically, the focus has been on mitigation, how do we reduce emissions, and this absolutely has to continue. Additionally, this year, the other focus will be adaptation. You know, adaptation looks at how to improve resilience of those communities affected by climate change, which do tend to be the emerging and developing markets. And, given implied temperature rises we were just talking about, this is increasingly necessary.  

As well, finance is going to be on the agenda, I think, in two ways. First, is getting developed countries to provide the $100 billion a year that they’ve committed to, to assist developing countries. Last year they made it to $83.3 billion, but still, that’s not enough and certainly not enough to help them to adapt or to mitigate in terms of where climate is. 

And the second interesting one, I think, this year is to put real focus on a loss-and-damage mechanism, and this is really a request from the Global South, to those countries who have historically polluted, to provide funds to support the less developed and most-impacted countries, who have felt, as we talked about before, or will feel, the impact of climate change.  

You know, when you think about it, if we go back to Africa, Africa contributes 3% of the global GHG emissions, but it’s clearly feeling a much higher percentage of those effects. And as you’d imagine, the Global North is not going to be keen to have that conversation. 

So, these are critical issues, but I think drawing investment implications, immediate ones, is a bit more challenging, realistically. You know, the market is not as responsive to a COP announcement as, let’s say, a BoE or a fed funds move. So, what we see is decisions that are made at COP have to work their way through national agendas and then implementation, so it’s not a short-term process. 

However, investors should be looking at them as indicators of direction and magnitude of change, and this is where I think you can pick up signals and look to model transition risks. So, what are we going to be looking for? Announcements around highly impacted sectors or industries. You know, last year we saw the historic agreement of methane emerge, and actually the industry starting to be affected by that immediately and even more so now. 

So, this year what are we going to be watching for? Power again, oil and gas sectors, agriculture, industrials, transport, buildings, waste, a number of these sectors that are highly impacted by climate change, either as a transition risk or physical risks, are going to be the ones investors should be looking at. 

HP: OK. Try and sum it all up for us. Give us your final thoughts, and if investors are interested, where can they learn more? Where are the best sources to go to? 

DP: Well, we certainly are encouraging investors to review their existing portfolio, their current portfolio, at the same time they’re going to be looking over the horizon. 

So, if you think about a central pillar of a climate-ready portfolio, is to understand the risks, physical and transition risks, to your current portfolio holdings or potential holdings. And we can protect value in the portfolio through detailed analysis of ESG factors, measuring or cutting your carbon footprint, or reducing exposure to assets that are more at risk from climate change. 

However, as we’ve said, protecting your portfolio does not necessarily protect the planet. Fundamentally, our global ambition is to decarbonise our economies and human activity, and this means realigning economic activity. So, we need more capital, we need new innovations, you know, existing ones to scale. In fact, in our year-end outlook, which we have coming out in a week’s time, I’ll be reviewing the case to be looking at clean-energy sectors.  

Also, at the start of next year, we’re in the midst of revisiting and updating our three-part series for investors to get their portfolios climate ready, which covers how to set an ambition, how to take action, and then how to measure and manage their impact. 

I guess, if I was going to answer the question really simply, I think it’s as you said, Henk, at the beginning, right, we need investors to be looking at both risks and opportunities for their portfolio. 

HP: Well, thank you, Damian, for taking us through the key areas of debate and possible implications for investors. We will, of course, continue to monitor developments very carefully to see what tangible commitments emerge. 

Let’s move on to the week ahead, where the focus will be on the US midterm congressional elections, which are scheduled for Tuesday and will determine the American policy agenda for the next two years. 

To remind you, the United States Congress consists of the House of Representatives and the Senate. Senators serve six-year terms, of which one-third are up for election. Meanwhile, all 435 members of the House of Representatives will be elected. 

Political analysts are forecasting that the battle for the Senate is simply too close to call. The Republicans look set to win back the House of Representatives. Sitting halfway through the presidential four-year term, the midterm elections are traditionally seen as a referendum on the incumbent president. According to recent opinion polls President Biden’s approval ratings continue to hover at around their lowest seen in his term in office. 

History has shown the governing party invariably loses seats at the midterm elections. President Obama’s Democrats lost 63 seats in the House of Representatives at the 2010 midterms, while the Republicans lost 40 seats in the House in the last midterm elections.  

In fact, in the 40 midterm elections since 1862, the president’s party has lost seats in the House of Representatives 90% of the time. Despite the worrying historical precedent for the Democrats, there are a range of factors that appear to be energising the party’s base ahead of this election, including the conservative leanings to the Supreme Court’s decision to overturn the federal rights on abortion. 

Democrats have gained some momentum after delivering a number of legislative victories in recent months, including in key policy areas such as the economic recovery plans, infrastructure investment, healthcare reform, and climate-change initiatives. Democrats have also been ahead in fundraising, this time around. 

So, where are we in terms of the balance of power? What are the key battlegrounds? Well, in the Senate, Democrats hold 48 seats, Republicans 50 seats, two independents caucus with the Democrats. Democrats hold the majority in the Senate, due to the tiebreaking vote of Vice President Kamala Harris. Out of the 100 Senate seats, 35 are up for election this year. 

Of those 35 seats, 21 are held by Republicans, 14 by Democrats. The key battleground seats appear to be in Nevada and Georgia, which are held by the Democrats, and Wisconsin and Pennsylvania, which are held by the Republicans. 

In order to break that current 50:50 tie, it’s considered the Republicans will need to win three of the too-close-to-call contests to flip control back in their favour. I think, given the tradition of protest voting, their lead in the polls, the redistricting process, and the structurally higher turnout for Republicans, political forecasters, as I said, do believe the Democrats will lose control of the House. 

In terms of the impact of a split Congress on policy, well, a split or a Republican Congress, of course, will impact President Biden’s ability to deliver his key spending and tax policies in the second half of his term. The diffusion of power across the political spectrum would likely constrain Congress to deciding upon the appropriate levels of government funding and assessing expiring provisions. 

Conversely, if we were to see a Democratic-controlled Congress, that would reignite proposals for increases in corporate, capital gains, and income taxes. 

In terms of the impact on markets, well, over the course of the past century, equities have tended to underperform going into the midterm vote. However, as clarity over the political outlook improves so does the performance of stocks, though investors may have more pressing economic concerns this time around. 

Looking at performance of equities over the course of the presidential cycle, shows the midterm year, on average, delivers lower annualised US stock market returns. In fact, history shows you that year three, the pre-election year, delivered the best returns followed by year one and then year four. And, actually, somewhat counterintuitively, investors appear to prefer a split Congress.  

The average S&P 500 return when Democrats have held the presidency and Congress was split has been higher when government or the Congress was unified. So, perhaps investors will agree with the Founding Fathers, that a balance of power is not only good for politics but also good for stock-market returns. 

With that, I’d like to thank you once again for joining us. I hope you found this update interesting. 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.