Markets Weekly podcast – 26 September 2022

Henk Potts (HP): Hello. It’s Monday, 26^th September 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 implications of the dramatic change in policy by the UK government. Finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

A round of aggressive global interest rate hikes is doubling down the hawkish tones from central bankers, a new aggressive policy direction by the British government, and the escalation of the war in Ukraine set a distinctly negative backdrop for risk assets last week. Volatility surged, the VIX index, Wall Street’s fear gauge, jumped 9.4% on Friday. There was a broad-based equity market sell-off over the course of the week. The S&P 500 fell 4.6% and is off 23% during the course of this year.

In Europe, the STOXX 600 fell 4.1%, its worst weekly performance since the middle of June. In bond markets the policy sensitive 2-year Treasury yield settled around 4.2%, that’s close to a 15-year high. The 5-year yield briefly broke through 4%. As we know, money’s been flowing into the US dollar. The Dollar Index rose to a new record high and is now up 18.6% year to date. The euro slid to its weakest level since 2002 against the greenback, while overnight, sterling had fallen to its lowest level against the dollar since decimalisation in 1971.

Growing anxieties about the global economy and, of course, a stronger US dollar have been hitting commodity markets hard. Crude prices have registered four weeks of losses. Brent is below $85 a barrel for the first time since January this morning, gold trading down to $1,643 an ounce, which is now off 10% year to date.

In our recent Market Perspectives, we highlighted a number of risks that would turn output negative over the course of the coming quarters. Two of those factors shone through during the course of last week, namely, a further de-anchoring of inflation expectations, leading to the need for tighter monetary policy. And, secondly, the escalation of the war in Ukraine.

Let’s start with the Fed. The US central bank delivered its third successive 75-basis point increase, pushing the Fed funds target range up to 3% to 3.25%. The Fed chair vowed to keep hiking rates until inflation abates and labour cools down, despite the risk of recession. The hawkish comments from Jerome Powell were highlighted in the latest “dot plot”, where the median member expects 125 basis points of hikes during the course of this year and a further 25 in 2023. The forecast showed the benchmark rate rising to 4.4% by the end of this year and peaking at 4.6% in Q4 next year.

The elevated policy path reflects the Committee’s optimism around the view of growth but also its pessimistic view of inflation. The latest projections forecast the US economy will grow at 1.2% during the course of the next year, which is certainly higher than consensus, but inflation to remain higher for longer in 2023, with core PCE inflation averaging 3.1% during the course of next year.

In terms of the labour markets, the Fed appears to be waiting for a more pronounced slowdown. Key reports to watch here are the unemployment rate, also the JOLTS data, which reflects job openings and the quits rate. The Fed is forecasting that the unemployment rate will rise from the current 3.7% to 4.4% during the course of next year.

In terms of the policy impact, we now forecast the FOMC will hike rates more aggressively. We expect another 75 basis points in November, 50 basis points in December, and one more hike as we look into 2023. We think that will come in February, and that takes the terminal rate up to 4.5% to 4.75%.

Geopolitical risk increased last week after Russian President Vladimir Putin ordered a partial mobilisation. The decision to call up 300,000 reservists for the first time since the second world war is seen as a major escalation of his flagging invasion of Ukraine. The ratcheting up of the military action reduces any hope of an imminent peace treaty. It also increases the pressure on the European Union to implement a comprehensive embargo on Russian energy that’s due to come into force in December.

A recent report from the International Energy Agency showed that the European Union continues to import crude from Russia at the rate of 1.7 million barrels per day. That was down from, it has said, the 2.6 million barrels per day that they were importing back in January, with the US, Norway, and Kazakhstan accounting for much of that shortfall, but will still need to make up a significant amount in order to reduce the rationing that could potentially come into place over the course of the next few months for the European Union.

Despite the build-up in military action, gas prices in Europe have been falling. In fact, they’ve fallen for the past four weeks as supply of LNG is helping to fill European storage facilities, which are now 87% full, and governments implement energy saving measures, though prices are still six-times higher than the average you’d expect for this time of the year.

Moving on to the UK, as we said, the British government laid out a radical change in approach to the tax and spending policies of the country. Trailed as a mini budget, the policies put forward equate to the biggest tax cutting measures for five decades and will have broad ramifications for the economy, the nation’s finances, the planning process, and, of course, the regulatory environment.

In terms of the impact, it delivered a huge fiscal stimulus, which should be supportive of immediate growth. The energy support package will ease the UK’s inflation profile in the short term, although tax cuts could boost consumption, and, therefore, price pressures in the medium term. But, as we know, it all comes at a cost. We await the official costing by the Office for Budget Responsibility in November. The Treasury did estimate the cost of the energy support package, £60 billion, over the course of the next six months. The permanent tax cuts amount to around $40 to $45 billion of extra borrowing per year, which equates to roughly 2% of GDP.

In terms of market reaction, well, international investors appeared nervous about holding UK assets as debt surges and concerns that the fiscal boost will, indeed, stoke already elevated inflation in the medium term.

Sterling has slumped to an all-time low in Asian trading against the dollar, falling to 1.0350 at one stage and is off 7.4% over the course of the past five days. Borrowing costs, as expressed through yields on gilts, surged as the Chancellor delivered his sweeping changes. Five-year gilt yields hit 4.08%, that’s the highest since 2008, after jumping the most in a single day, mapped in data that goes back to the early 1990s.

Listless traders quickly moved to price in a 100-basis point increase at the November meeting, which will be the most aggressive hike since 1989.

So, what is the interest rate path from here? Well, as expected, the Bank of England hiked rates by an expected 50 basis points at last week’s meeting, pushing the base rate up to 2.25%, though the decision was a more hawkish split, with three members voting for a 75- basis point increase. We now expect the MPC to hike rates twice more during the course of this year with 50-basis point increases coming in November and December, pushing the expected terminal rate up to 3.25%, but we should acknowledge, of course, those risks remain very much skewed to the upside.

So that’s the market reaction to the Budget. In order to discuss the political outlook in the UK in some more detail, I’m pleased to be joined by Olivia Gleeson, who is Vice President of Government Relations and Policy for Barclays UK.

Olivia, great to have you with us again. We’re two weeks into the new government. What are your main takeaways in terms of their operating style, policy priorities, and, of course, politics?

Olivia Gleeson (OG): Great. Well, thanks for bringing me in. I mean it’s been an absolute whirlwind, I think. I can’t quite believe it’s only been two weeks, but a few interesting strands to unpick here.

Firstly, Liz Truss, our new prime minister, and, indeed, all of her cabinet, I think I would describe them as sort of conviction politicians, and that’s important, because they’re sort of willing to go against the grain of sort of popular or public opinion to pursue their orthodoxy. And I’ll come into it in more detail, but, you know, take for example the lifting of the cap on the bankers’ bonuses. Now, many might have shied away from that move against the current economic backdrop, you know, particularly the cost of living, but this government is clear that it wants to pursue what it believes is the best economics, the best politics to help deliver growth.

And I think the second thing we’re seeing related to that is, you know, a doubling down in Truss’ personal politics. We heard a lot during the leadership campaign about her vision for sort of a low tax/high growth economy, and since then we’ve continued to see that sort of Reaganite approach. And they have a relentless focus on competitiveness and growth, so I think we should expect to see a lot more in that mould in the coming months.

And then, finally, I’d also mention I think it’s of relevance to Barclays, but also to our listeners, that, you know, this government is sort of unabashed on regulators. They want to sort of see a rollback of the state and leave much more policy to market forces to dictate, which, I think, is a little bit of a departure from sort of the previous Conservative governments we’ve seen.

HP: As we’ve been discussing, on Friday we saw the so-called mini budget that’s so much more than that, of course, the first of a new Truss administration. What is your read on the announcements?

OG: Yeah, I think you’re right to sort of express some scepticism about how mini that budget was. It was a little bit mega. We obviously had the new chancellor, Kwasi Kwarteng, describe it as a new approach for a new era and I definitely think, you know, it was a bold package for a pretty big moment.

So, I won’t recap the announcements because I know that you and listeners will all sort of be aware, but, of course, we did see a lot of tax cuts. Some were pre-trailed, but some were a surprise. For example, the scrapping of the 45% additional tax-rate cut from April 2023 and, of course, that’s all on top of, sort of, the energy package of support that you also touched on.

And I think we also saw, I should mention briefly, you know, a strong signal of support for the City of London and financial services in that budget. Now, of course, Truss will be hoping that her approach and these announcements will help usher in a new era of economic growth after decades of stagnation, but I think, you know, behind the budget is particularly interesting to look at.

Now, of course, you know, we shouldn’t forget this agenda is sort of, in large part, driven by a need to appeal to the Conservative party core. They’ve long been pushing for the government to return to that sort of traditionally low-tax credentials of the Conservatives. That being said, you know, I wouldn’t say that this new radical approach is being met with sort of open arms right across the Conservative wings, and, of course, there will be some looking on at events, wondering if the government is potentially doing too much, too fast. It is really quite a radical agenda.

I think, you know, the other thing, or factor I should I say, to sort of bring in here, is it’s important to bear in mind the wider context in which this government has delivered this first budget. You know, not only do we have that sort of extreme public pressure in view of the cost-of-living challenges I’ve already mentioned, but I think the strength of the Labour party is a particularly important factor we should dwell on for a second.

Now, Labour have a double-digit lead on the Conservatives in the majority of polls and I think the consensus in government, and we can certainly see that in this budget, is that it will take a lot to try to overturn Labour’s momentum, and that’s, perhaps, why we saw that sort of, you know, ‘go big, go home’ mentality as the government seeks to establish very clear political dividing lines with the Labour party ahead of the next general election.

HP: So, after that dramatic start, let’s look forward a little bit. What should we be watching out for from a political perspective over the course of the coming months?

OG: Yeah, it’s a good question. I think, you know, broadly speaking, I’d probably say, look, I think I just touched on it, but, you know, to expand, you know, there is only a small window of opportunity for that, the dye is properly cast potentially with this government. I’m talking both in terms of, you know, whether they capture public support this side of Christmas, and, you know, I use that timeframe deliberately because the first 100 days of any new prime minister or any new government is also considered crucial, but also because, as I mentioned, this economic backdrop is so challenging. I think the new government only has some briefest of moments to try and convince the electorate that they can make a difference.

And I think I also previously touched on it, but to expand, you know, that the problem which is particularly pertinent perhaps with a general election only around 18 months or so away. I think the Conservatives know that they have a big task ahead of them to set out, you know, a radical policy agenda and convince the electorate that they are the right governing party.

Particularly relevant right now, I think, is the speaking at the party conferences. Labour’s is underway now and the Conservatives is kicking off next weekend. And I think, for Labour, this will be a really interesting moment and they’ll be able to sort of clearly differentiate themselves from the Conservatives.

I think it’s fair to say, you know, as viewpoints during the previous three years the parties actually appeared quite similar, but I think the differences are now increasingly marked and Labour will definitely be looking to sort of capitalise on that with a series of big announcements over the next few days about how they will be a different type of government to the Conservatives and to try to recapture public support.

You know, the Conservative party conference rather will follow next weekend, and I think Liz Truss and her cabinet will be looking to, sort of, unite the party, demonstrate sound and expert credentials, you know, settle a few nerves about the economy, and, finally, sort of outline a very convincing plan to overturn that Labour momentum. So plenty to watch out for just in the coming weeks and months ahead.

HP: Well, thank you, Olivia, for sharing your insights. We know that markets will be watching this experiment very closely for both risks and opportunities across asset classes. No doubt we’ll come back to you in the near future to discuss that path of policy.

Let’s move on to the week ahead. In the US on Tuesday, we expect that new orders for durable goods fell 0.3% month on month in August, driven by weakness in the volatile non-defence aircraft category. We expect US home price data to continue to show the deceleration that started back in June. For July, we project that the 20-city S&P CoreLogic measure to increase by three-tenths of 1% month on month, 15.8% year on year.

Over the next 12 months, there’s likely to be downward pressure on house prices, causing them to decelerate to zero growth, or potentially decrease, given elevated prices and rising mortgage rates.

On Friday, we get the September PCE price index in the United States. It’s expected to show an increase of 0.2% month on month, 6.3% year on year, which will be softer than the August CPI estimates.

In Europe, the focus will also be on those inflation figures. We get them on Friday. Expectations are that price pressures will reach a new record high in September. Consensus forecasts suggest that CPI could hit 9.6% year on year, as food and energy prices continue to rise.

And, with that, we’d like to thank you once again for joining us. I hope that 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.