Markets Weekly podcast – 7 August 2023

Julien Lafargue (JL): Welcome to a new edition of Barclays Private Bank’s Market Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and this week again I will be your host. 

As usual, we will start by reviewing last week’s main events before talking to our guest speaker. And, this week, as we all experienced a very wet and relatively cold summer in the UK while other parts of Europe and the world are baking in record heat, I’ll be joined by Damian Payiatakis, Head of Sustainable and Impact Investing at Barclays Private Bank. We will get Damian’s thoughts on what the unusual weather patterns mean for us. 

But, first, let’s start by analysing the week that was. So, after the close on Tuesday, 1st August, Fitch, the rating agency, downgraded the US credit rating from AAA to AA+. The rating agency had put the US on watch back in May during the debt-ceiling gridlock. It flagged, in their release, expected fiscal deterioration over the next three years, a high and growing general government debt burden and the erosion of governance as reasons for the downgrade.  

The move was somewhat surprising as the downgrade did not contain any incremental fiscal information but, given S&P’s downgrade back in August 2011, the reaction was relatively muted. 

Importantly, there should not be any meaningful forced seller of Treasuries due to this downgrade. Indeed, following the S&P’s downgrade, most banks and investors have adjusted their investment parameters so they wouldn’t have to exclude US debt, which, of course, remains one of the most liquid and widely traded fixed income instruments. 

Another important point is the fact that Fitch did not adjust its country ceiling. That means that other AAA-rated securities issued by US entities, such as government-sponsored entities or municipalities, will not be impacted by that downgrade. So, overall, a lot of noise but not a huge impact, at least not so far. 

Now, bringing things back closer to home in the UK, the Bank of England raised interest rates for the 14th consecutive time, tightening by the 25 basis points, as the consensus had expected. The bank rate is, therefore, now 5.25%.  

While the accompanying statement left the door open to further tightening, Governor Bailey for the first time defined the policy stance as restrictive, which means that the Bank of England seems to be very close to being done when it comes to this particular hiking cycle. 

As a result of those comments and the overall tone of the press conference, Barclays Investment Bank is now expecting the bank rate to peak at 5.5% in September versus 5.75% previously, so basically removing one additional cut from the equation, and this is broadly in line with the market’s current expectation. 

Now, finally, in the US we got the all-important nonfarm payroll report for the month of July. Headline nonfarm payrolls were up 187,000. That was slightly below the consensus. The consensus was looking for 200,000. It was also the lowest print since December 2020. In addition, the prior two months were revised by a combined 49,000.  

The unemployment rate, which relies on a different survey, there is the Establishment Survey and the Household Survey, the Household Survey actually showed better job growth and as a result of that, because this is the survey that is used to compute the unemployment rate, we saw that rate come down 0.1 percentage points to 3.5%. The consensus was actually forecasting a relatively stable rating at 3.6%. 

The other key part of this release has to do with compensation, wage growth and the average workweek. Again, a relatively mixed picture here. On the wage front, average hourly earnings came in at 4.4% year over year. That was slightly, again, higher than expected and it was basically unchanged from last month. On the other hand, though, the average workweek, so how long people actually work, was lower than the consensus forecast, tying a cycle low. 

Following this print, the policy sensitive two-year Treasury yield fell sharply as the overall interpretation of those numbers was that the hours worked would offset other wages, dampening the overall compensation growth. And, following this print, the fixed income market, which was pricing in a first cut for the Fed in May 2024, brought that forward to March 2024. So, a lot of changes in terms of market expectations, whether it's from the BoE or the Fed last week.   

Now, let’s move on to our guest segment and we have a lot to talk about. Climate change and our global response is a topic that we’ve seen increasingly in the new cycle and with COP28 in the UAE later this year, we will likely have more coverage in the coming months, but with the summer upon us, we might expect a respite. 

Since COVID-19 restrictions have been lifted, people all over the world have been flocking back to their favourite holiday destinations. I know that I’m going on holiday soon. In Europe that generally means to the Mediterranean and to beaches. But holidaymakers have faced scorching temperatures and even had to flee wildfires in parts of the world. 

So, joining me today, before we actually both head out on summer holidays, is Damian Payiatakis, Head of Sustainable and Impact Investing at Barclays Private Bank, to talk about one of the most British of topics, the weather. Or, more correctly, the physical impact of climate change. 

So, Damian, first of all, thanks for joining. Maybe we can start this conversation by me asking you a quick question around the weather and, you know, through the lens of climate change how the summer has been so far for us. 

Damian Payiatakis (DP): Hello, Julien, and thanks for having me here. I think just to evoke the word that dominated the pandemic, the summer has been unprecedented. We know weather has always been variable. Extreme weather events have occurred in the past, yet these events are becoming more frequent and more intense with climate change, so let’s look at that.  

This summer, let’s start with temperatures, June was the hottest month ever on record, and July may supersede it once the measurements are confirmed. 

Currently, when we look at the Southern Cone, so Chile, Uruguay, Argentina, Brazil, it’s winter, so temperatures should be in the 5 to 10 degrees Celsius range. Instead, they’re in the high 30 degrees. And in contrast to the parched regions, precipitation has inundated others.  

So, June may have been the hottest on record, but it was also the second wettest on record, and in some cases massive swings occurred in the same region. So, for example, here in the UK, the overall rainfall in June was 68% of the average. In July, it was 170% of the average. 

So, we’re also seeing multiple oceans warming to new records and the challenge there, of course, is when temperatures rapidly rise, coral reefs, like those in the Caribbean, have been completely bleached in mere weeks. So, at the same time, we also see Antarctic sea ices shrunk to record lows. So, compared to averages just a couple of decades ago, an area about 10 times the size of the UK is now missing.  

And not only in the Mediterranean, but also summer wildfires, which started in June in Canada, have continued to rage throughout the summer. This has now recorded the largest burned area in the country’s history, and I think what we’re seeing now has been expected by climate scientists, but what’s interesting is many have expressed the surprise at the magnitude and also how quickly this physical impact has arrived. 

And I should say, it’s also with an average global temperature of only 1.1 to 1.2 degrees Celsius above pre-industrial levels.  

JL: And that’s a very interesting point because a lot of people would question that number, that one degree, thinking that it doesn’t really matter. Hopefully, the recent extreme weather that we’ve seen will help people realise that, you know, one degree can mean a lot and there are definitely changes happening when it comes to climate.  

Now, we’re an investing podcast, so let’s bring it back to that topic and maybe you can tell us what all those extreme fires, floods, higher temperatures mean for investors. 

DP: Well, simply more risks and more potential impact. So, as you say, right, we’re an investing podcast, let’s take a step back. 

Investment, corporate, government communities are generally looking at two kinds of financial risk from climate change, transition risks and physical risks. Transition risks are structural, they’re the systemic changes, the climate change, and also all of our efforts to address it, are going to have on the companies and on investors, things like policy and legal risks, market demand risks, technology risks or reputational ones. 

What we’re talking about here are the physical risks and the physical effects of climate change, and their impact can be through acute weather events, such as the wildfires or, you know, we’re getting to hurricane season, so as oceans are warming we’re getting increased effects of hurricanes. And these are the chronic risks. As well, where we’re also looking at effects of longer-term changes to trends, for instance, you know, with extended droughts affecting crops or extreme heat making construction at certain times just impossible, and obviously in combination both of these can be particularly devastating. 

So, investors have to assess whether the financial risks may occur depending upon the likelihood of primary physical risks and any secondary implications. Now, what we know is all sectors of the economy are going to face both types of risks and that’s why bodies such as the Taskforce on Climate-related Financial Disclosures or the Transition Plan Taskforce were established. They really provide us with frameworks and guidance to assess the change and the consequences of any particular risk, and the impact of that will vary quite frankly by sector, by company, even by location. 

JL: Right. So, if we do have this risk framework that you just described, should we have expected the extreme weather that we’re witnessing at the moment? 

DP: Well, partially, but there’s also a hiccup, particularly with the economic models that we’re relying on, our expectations around the financial implications. There’s a recent report from a client research house called Carbon Tracker, and they found that our current economic research and the models that estimate the financial impacts of these risks ignore really critical scientific evidence about financial risks within this rapidly changing climate. So, I’m not going to suggest that obviously it’s a beach read, unless you get very enthusiastic about implications of quadratic versus linear or logistical models in terms of predictive analysis. So, let me just skip to the conclusion. 

It really just says that our current models haven’t fully integrated climate risk and, therefore, it means that we may be significantly under-pricing the systemic risks that investors now face. And, well, unfortunately, this wouldn’t be the first time mainstream economic models have been inaccurate, as we saw during the global financial crisis. 

JL: Or more recently the pandemic, to be honest. All right. So, again, bringing it back to investments. With those risks, the risk of underestimating the risks, what can investors do? 

DP: Well, I guess it’s just like it’s a bit late to crash diet to be beach-body ready, investors shouldn’t be looking to take immediate drastic action, nor, at the same time, should they end up being what’s deemed as taking a ‘doomer’ perspective, that it’s too late, that we should just continue as is, or just try to adapt to it. 

Climate change is clearly a global and systemic issue and with collective action we can overcome it, and there has been tremendous progress that’s already been made. So, I think in some ways, for investors, the biggest risk is actually to do nothing. With the physical effects of climate change seeming to arrive earlier than we expected and, therefore, posing greater material financial risks, investors need to really start thinking about how to consider to incorporate these physical risks into their portfolios.  

And at the same time, investors can look for solutions to help to address the underlying causes. I think seeking opportunities to be more proactive can benefit both planet and portfolio as well as investors, the opportunity to feel like they’re making a personal contribution to address this issue. 

JL: Yeah, there’s clearly a lot that can be done. It feels like an insurmountable task but there are things, and if we all play our part, hopefully, we will continue to be able to enjoy, let’s call it normal as we know them, holidays. 

That was great. Thanks a lot. I mean there is so much that we can cover. We’ll definitely have you back, but maybe any final thoughts for the listeners? 

DP: Well, I would say, as I said before, the biggest risk is to do nothing, so probably make a note for your return. Even if it’s as simple a question as asking or trying to understand the risks that you might be facing.  

But at the moment enjoy the summer as it is. It may not be normal, going forward. I know the UK national weather service, the Met Office, forecasts that if we continue at the current pace and rate, what we’re experiencing today may be considered average or even cool in 20 or 40 or more years’ time. 

So, with that in mind, I would say the last thing, obviously, is just to make sure to reapply sunscreen. 

JL: Very good, very good words, thank you. Thank you, again, Damian, that was great. Well, again, the COP28 is coming so we’ll definitely have more of those conversations. I think this is a topic that needs to be forefront when it comes to our lives but also our investment practices, so thanks again. 

Now, before we conclude, a couple of items to put in your agenda for this week. We will get the China CPI and PPI data reading on Wednesday and, after that, all eyes will be on the inflation numbers from the US for the month of July. These will be out on Thursday. 

Apart from that, in the current context of the spike in bond yields that we’ve seen, the steepening yield curve and the downgrade by Fitch that we mentioned, we will be monitoring the US government debt auction schedule for this week. We have three auctions planned, 42 billion, 38 billion and 23 billion of 3-, 10- and 30-year paper respectively. 

Beyond that, let’s hope for a relatively quiet week, whether it’s on the markets or weatherwise. That is it from us. We will be back next week and, in the meantime, we wish you all the best for the coming week.