Markets Weekly podcast – 18 September 2023

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

As usual, we will start by reviewing last week before moving on to our guest segment. And, this week, I’m very pleased to be joined by Damian Payiatakis, our Head of Sustainable and Impact Investing, to talk about the most extensive assessment of global action on climate change to date. But before, let’s take a look at the week that was.

It was a fairly muted week in terms of equity market return with a clear outperformance of the rest of the world versus the US. The main event of the week was clearly the ECB decision. Going into the meeting, at least a week before everybody was expecting the ECB to stay put this month. However, about 48 hours before the meeting, a Reuters article came out saying that the ECB staff would actually revise their inflation expectation, showing that inflation was expected to remain above 3% going into 2024.

And, as a result of that, the market started pricing in the possibility of a hike by the ECB, and that hike materialised with the central bank deciding to move ahead and hike by 25 basis points to 4%. However, and interestingly, the reaction on the market side was fairly dovish. The euro came down, rates came down, and I think there are a couple of reasons behind that.

First, it was a relatively dovish hike in the sense that the ECB signalled that this was, potentially, the last hike of that cycle and that the central bank was fairly happy with rates where they are at the moment. The other key reason for the dovish reaction was the fact that the central bank itself revised lower its growth expectation for the foreseeable future, again, giving signs that a further hike is probably not needed at this point. Barclays Investment Bank now expects the ECB to be on pause until July 2024, when a first cut could materialise.

Now, moving on to the other key moving piece of last week, and it was really China. And that was another key factor contributing to the rest of the world’s outperformance. Local authorities there continued to announce various measures to kick start their economy. Last week was a reserve requirement ratio cut for the banks, in trying to bolster supply of credit, although demand remains rather tepid.

And the macro picture seems to be turning a corner after the manufacturing PMIs, trade, credit data. Last week was retail sales and IP, industrial production, which also beat expectations. So, it looks like China could be on the cusp of a recovery, although despite this more constructive mood all around, there is a dark cloud in the sky in the form of oil strength. Indeed, WTI surpassed $90 a barrel last week for the first time since Q4 2022 and, obviously, this is raising concern that we could see further inflationary pressure in the coming months as this oil strength is passed through along the value chain.

Now, I think for investors it’s important to realise that markets tend to behave like a pendulum. Sometimes it swings too hard to one side, before coming right back too far on the other side. If we look at Q4 last year, we were probably on the very pessimistic side of things where people were expecting Europe to freeze to death almost with no access to Russian gas, and the reality is that it didn’t materialise.

And, going into the beginning of this year, the pendulum swung back to a much more optimistic view of the world, and then again and again. And it looks like we are at this point where the pendulum is going back or shifting again, this time towards a more constructive view of the world. As I mentioned, China seems to be bottoming, central banks look like they’re done hiking, and growth, especially in the US, remains very resilient.

But let’s be clear, we don’t think that we are out of the woods just yet and it’s when markets expect it the least that a negative surprise will hit. So, with that in mind, the message remains the same, stay invested but stay prudent.

Now, that’s the world market. Let’s move on to our guest segment with Damian to talk about climate change a bit. So, Damian, great to have you back on the podcast.

Damian Payiatakis (DP): Thanks, Julien, pleasure to be here.

JL: So, Damian, in this month’s Market Perspectives you wrote about the multiple warning signals the Earth provided over the summer in terms of the impact of climate change, ranging from wildfires and heatwaves and floods and drought. Along these lines, I think it was a little more than a week ago, the UN published its first global progress report on our global efforts to mitigate and adapt to climate change.

The title was Global Stocktake¹. What are the headline messages on this report?

DP: So, very simply, we’re² making progress but not enough. The report reviews the efforts from 2015 to mitigate and adapt to climate change. It recognises that the Paris Agreement has inspired significant progress which has reduced our likelihood of the worst-case scenarios of future warming, I think, but it also really just confirms what we’ve all known, collectively we’re far from achieving our ambition to address climate change and, foremost, there’s a massive emissions gap to meet an interim target to halve emissions in the next six years.

The report’s blunt conclusion is, very simply, “much more is needed now on all fronts”. More tangibly, let me put it this way. In 2010, we were on track for temperatures to rise between 3.7 to 4.8 degrees by the end of the century. And now, the expected rise is 2.4 to 2.6 degrees.

JL: Sorry to interrupt, but that’s definitely not the 1.5 target or the 2 degrees maximum that we continue to hear being used.

DP: No, absolutely not. So, let’s take a step back. Nationally determined contributions, NDCs, are to climate change what New Year’s Resolutions are to weight loss or becoming healthier. Countries are basically saying, here’s the level of emissions to which we aspire to get. But then you need policies and plans to achieve those goals. And then you need to actually take tangible actions to achieve them.

So, this Global Stocktake is the first official health check or moment we’re sort of stepping on the scales to see our progress and, unfortunately, it’s saying that we’re off track.

JL: So, why is this called Global Stocktake? And I think whenever you see a report like that, there is always a question about methodology and how people got to the whatever conclusion they reached. So, how in this case, how did the scientists reach those conclusions?

DP: Well, it’s a really extensive piece of work. It’s taken more than two years for the team to pull it together. They distilled over 1,600 documents from a wide range of sources. They collected data globally from both scientists and governments. And also, interestingly, they engaged cities and businesses as well as civil society and even indigenous people. The report focused on three key topics: mitigation, adaption and implementation support.

So, first, how well are countries reducing greenhouse gas emissions today, and finding new ways to cut emissions? That’s the mitigation side. Then, adaptation. So, how are companies improving resilience to the climate impacts and to reduce vulnerability of their citizens and their infrastructure? And then the third piece, how much progress is there in securing finance, providing capital and support, especially to developing nations who are struggling to finance, but also are the ones often more impacted by these climate, physical-climate impacts.

So, after a year of collecting and then culling the data they then spent a year assessing it, holding dialogue, synthesising the views and input from all these sources, and this formed the technical assessment that was just published.

JL: Yeah, so I guess I’m also often sceptical when I see those reports and those findings. They somewhat seem obvious yet, every time there is a new report, it looks like nothing really has happened. So, what happens with the findings now? What are we going to do about that?

DP: Well, importantly, because it’s driven and sponsored by the UN, they form a critical part to COP28, which is in December. We’re now about 70 days, I’d say, away from COP28 kicking off. So, after this data collection and the technical assessment, there’s a third and final phase of the process which is probably the most critical point to what you’re saying.

Countries are going to respond politically to the gaps and opportunities identified in the report. What happens is during COP, country delegates will discuss the technical findings, identify sort of opportunities and challenges and good practices for more action. Then, they produce a collective summary and then this should be referenced in that final COP statement.

And that really formalises the commitments of all countries, because all countries will sign that final statement to future commitments and action plans. And, thereafter, the expectation is this Stocktake will drive revised national determined contributions, those NDCs, before the next deadline in 2025.

JL: OK. So, I guess we’re a financial podcast, so let’s bring it back to markets and investors. What should investors do about all that? Is there anything that they need to be thinking about or considering for their portfolios?

DP: Well, while it is hard to predict how individual governments will respond and, therefore, exact implications, I think foremost it re-emphases this direction of travel and also the need to accelerate. The report makes 17 key findings that I think we can look to for insight.

So, for example, it calls for “scaling up renewable energy while phasing out all unabated fossil fuels”, and it calls for “electrification, energy efficiency, demand-side management as well as energy storage”. And it also states that “industry, transport, buildings and other sectors must rapidly reduce process and energy emissions”.

So, all of this very clearly is indicators of where countries, and also industries, are going to be affected in terms of transition and physical risks around what it is they need to be doing.

You know, additionally I also found it interesting in the report to see a call for more systemic transformation. So, that means not only improving individual technologies but also acting more holistically. The report suggested “a rigorous, ‘all-of-economy, all-of-society’ approach is needed across all systems and sectors”. So, to me, if governments and other actors take that approach, it opens up a lot more opportunities and the potential to see change happen even more rapidly.

It also means a greater likelihood of near-term disruption for incumbent industries as well as vulnerable communities in terms of their transition and making sure that it’s just. And I think, arguably, we need it. I mean, you mentioned my last Market Perspectives article. I think what disturbed me most, as I listed out all those warnings, was not simply the unprecedented scale and range of the physical impacts, but, first, how scientists are being surprised by how much earlier we’re seeing these impacts emerge at much lower temperatures.

We’re only at around 1.2 degrees average temperature rise. And also, the other thing was that dominant economic models don’t fully account for these impacts of climate change. We’ll see how the Stocktake is leveraged at COP28 to drive more action. And also, I think we’ll see how we’re doing after the next Stocktake, which is in 2028.

JL: Well, Damian, we’ll definitely hold a slot for you for that next publication date in 2028.

Now, moving on to the conclusion and looking at the week ahead. It will be a very busy week, especially on the central bank front. The main focus will certainly be the Fed’s decision that’s coming up on Wednesday. Here, the market is expecting the Fed to be on pause this month, potentially hinting at a hike in November which, at least in the eyes of the market, should be the last one of this cycle.

The key element to watch for that release will be the infamous ‘dot plot’ and, clearly, a surprise could come when it comes to the 2024 dot. As it’s likely to move higher in a bid to try and force the market to realise that rates aren’t coming down any time soon. But we’ll see.

And we’ll also hear a lot from other central banks actually, including China, Japan, Norway, Sweden, Switzerland and, closer to home, the BoE. And most of those will take place on Thursday.

We’ll also be watching a few inflation numbers this week. German PPI, the Japanese CPI as well as, of course, the UK CPI.

And to finish this very busy week already, we’re going to have a quick look at the Flash PMI for September on Friday morning. So, definitely a lot to cover when we come back next week.

In the meantime, as always, we wish you all the success in the trading week ahead.