Markets Weekly podcast – 18 November 2024
18 Nov 2024
UK inflation and global growth
24 June 2024
Tune in as Lukas Gehrig, our Quantitative Strategist, discusses the long-term macroeconomic outlook, with a focus on growth, inflation and central bank policy. Meanwhile, host Henk Potts explores falling UK inflation, the latest data from China and the Swiss National Bank’s decision to cut interest rates.
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Henk Potts (HP): Hello, it’s Monday, 24th June, 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 consider the capital market assumptions that investors should be considering. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
It was a relatively constructive week for equity market investors, as markets reacted to easing inflationary pressures and hints of future rate cuts. However, political turbulence in Europe, sluggish PMI and mixed data coming through from China capped gains.
The S&P 500 was up over the course of the trading week. In fact, it registered a gain of six-tenths of 1%. In Europe, the benchmark STOXX 600 was also in positive territory, rising eight-tenths of 1% over the course of the week.
Treasury yields posted modest gains. The 10-year rose round about four basis points, to close the week at 4.72%. Now, concerns over the French election means that the gap between the French and German 10-year yields remained elevated. French yields traded at a 75-basis point premium to their German counterpart on Friday. That’s within touching distance of the 80-basis point step the week before, which was the widest that we’ve seen since February 2017.
In terms of commodity markets, investors continue to reduce their ETF goals to holdings. They cut their positions for five consecutive sessions last week. Total gold held by ETFs is now down 5.8% this year. While the precious metal is still up 14% year to date, it’s only trading around $2,360 an ounce.
The big surprise for the week, well, that was delivered by the Swiss National Bank. They cut the rate for a second consecutive meeting, reducing it by 25 basis points to 1.25%. The move came as the central bank cut its inflation forecast. The SNB is now projecting inflation in Switzerland will average 1.3% during the course of this year, 1.1% in 2025 and just 1% in 2026.
The decision, you have to say, is also a reaction to the strengthening Swiss franc, which has been rising against the euro as demand for a safe-haven currency increases, as a result of that political turmoil that we’ve been seeing in Europe.
On the macro side in the UK, the focus was on the latest inflation print and the Bank of England’s interest rate decision. Let’s start with inflation, where CPI decelerated back to the 2% targeted level for the first time since July 2021, down from the 2.3% that was registered in April.
Remember, that compares to that multi-decade high of 11.1% we saw back in October 2022. The easing has been driven by lower price pressures in food, the cut in regulatory household energy bills and the moderation in entertainment price rises. Core inflation also softened, slowing to 3.5% from the 3.9% reading that we saw in April, helped by weakness in core goods which has now fallen into deflationary territory.
In spite the overall easing, policymakers, I think, will still be concerned about the elevated levels of services price inflation, which is still running at a pretty punchy 5.7%. However, the May inflation report, as we know, was not enough to persuade the MPC to cut rates. As expected, it kept rates on hold at that 16-year high of 5.25%. Despite raising its growth forecast for the second quarter to half of 1%, that compares to the just two-tenths of 1% projection they made back in May.
I think the MPC was cognisant of April’s higher-than-expected consumer price index print. They also, I think, need to observe general election protocols. Seven members voted to keep rates on hold and two for a cut, but they did say the decision was finely balanced.
So, where do UK rates go from here? Well, given the recent progress on inflation, the easing of labour market conditions, remember, UK unemployment rose to 4.4% in April and the highest that we’ve seen September 2021, and the European Central Bank’s June interest rate cut, we think that should leave the door open for a potential rate reduction at the August meeting.
In fact, markets are now pricing in more than a 50% chance of that taking place. We forecast that the MPC will implement a 25-basis point reduction at the August, November and December meetings, followed by three further quarter-point cuts in 2025, thereby taking the bank rate down to 3.75% by the time that we get to August next year.
Moving on, the other big dataset of the week was out of China, where, after a prolonged period of weakness, China’s economy has been displaying some signs of revival. The recovery still remains very mixed and structural issues continue to weigh on the economic outlook. The latest data showed that manufacturing and exports appear to be holding up. Consumption levels, you could argue, have been stabilising, but property continues to be a major drag on the economy.
Now, backed by state support, manufacturing investment surged 9.6% in the first five months of the year. Retail sales accelerated 3.7% in May year on year, though demand was boosted by a public holiday. Despite a raft of new government measures, the property sector pain continues to play out. New home prices fell a further seven-tenths of 1% month on month. In fact, have declined for 11 straight months now, whilst property investment fell more than 10% in the year through May.
In terms of the outlook, consumer demand is expected, actually, to come under renewed pressure, as wealth dynamics continue to soften, and the labour market continues to weaken. Chinese policymakers have acknowledged the economic fundamentals are weak, have embarked upon a series of supported policies, particularly, as we said, for the ailing housing market. However, we think authorities will need to continue to offer innovative solutions if the troubled sector is not to act as a drag on the economy and, of course, social stability.
Given the positive start to the year, we do think that China will be able to achieve its 5% growth target for 2024. However, the weakness in domestic consumption, the softening that we’ve been seeing in terms of the labour market and tumbling property investment suggests that, as we said before, that the recovery is, indeed, fragile. Therefore, without the radical fiscal and structural reforms required, China is still expected to continue to underperform its potential.
So, that was the global economy and financial markets last week. In order to take us through the latest review of our capital market assumptions, I’m pleased to be joined by Lukas Gehrig, Quantitative Investment Strategist at Barclays Private Bank.
Lukas, great to have you with us today. As we’ve mentioned, we have refreshed our capital market assumptions. These are the long-term projections for macroeconomic and for financial markets. What has changed compared to a year ago that prompted this refresh?
Lukas Gehrig (LG): Well, thanks for having me back, Henk. This refresh is actually part of a periodic review that we do once a year to be able to provide more up-to-date projections for returns and risk, and to explore whether our strategic asset allocation is still fit for purpose.
But, either way, 2023 and this year so far were quite eventful for financial markets and economics. A couple of important events that happened include the normalisation in inflation that we’ve seen, the growth slowdown in Europe and, more recently, the start of the rate-cutting cycle.
A notable event that did not occur, but that we thought would, is the slowdown in US growth. Now, in terms of markets, European fixed income has already realised large chunks of devaluation gains, that we were forecasting last year, until now already and equities, both in the US and Europe, have gotten a lot more expensive.
So, all in all, there would have been many reasons either way to update the numbers.
HP: OK. Can you dive deeper on the updated macroeconomic outlook? What are the growth and inflation profiles that we’re expecting, and how do you see central bank policy evolving in the long run?
LG: I would say that after divergence among developed markets, in the sense that the US economy, which is really consumption heavy, was turbocharged by physical stimulus that went directly into the consumers’ pockets, while Europe went through various degrees of mild recessions, we now see convergence on the horizon for the next two years, so a convergence of growth profiles that is. The US economy should dip below its potential growth but temporarily, and European economies are expected to accelerate.
In emerging markets, we are now expecting this baton-pass moment, where India now becomes the most significant growth driver while the Chinese economy, as you have just mentioned, struggles and is expected to continue to struggle in the near term.
In terms of inflation, we expect US inflation to cool down over the next year or so, such that on average over the next five years, all our inflation projections are back within the central bank target ranges.
On policy rates, your listeners will probably remember Michel Vernier bringing up the topic of a neutral rate of interest, or r-star, up on his podcast last week. Well, we estimate r-star, and for it’s really the North Star in terms of guiding long-term policy rate projections, but, unlike some Fed members, we do not have r-star estimates as high as 3%, but we rather think it should be somewhat above 2% for the US and the UK, and slightly below 2% for the eurozone.
However, the way to these targets should be very gradual. Interestingly, this lifts short-term cash rates over five years above inflation for the US dollar, pound sterling and euro, something that we have not seen for 15 years now.
HP: As you mentioned, we did see the valuation gains that materialised through the course of 2023. What other implications does this have in terms of the outlook for asset class returns?
LG: Well, for returns, we employ a building-blocks approach which allows us to break down our projections into three building blocks, namely, income, growth and valuation, and that works for all core asset classes.
As we just said, a lot of the repricing action in fixed income on the back of rate cuts in Europe has already materialised, and along with its yields, which is the core component of income, have declined in the eurozone. So, all in all, our five-year projections for government bonds of the European markets have been lowered some 1% to 1.5%.
US fixed income really stands out, as a lot of the expected valuation gains are yet to materialise and, therefore, the return outlook has been up rather than downgraded. Our return projections for government bonds stand between 3% and 5.5% annualised, depending on the market.
For investment grade this is subject to the same divergence in the devaluation component, such that US investment grade should return the highest, close to 6%, the UK around 5% and the eurozone investment grade just below 3%.
High yield debt. Well, it’s expected to return just slightly more than investment grade, and this is due to spreads, which currently are still very low in a historical comparison and are expected to widen.
For equities, returns have been nudged down by around 1% across regions, but for different reasons. For European equities, the growth contribution has been lowered along with our inflation expectations, whereas for US equities we are expecting a lower income component, which takes the form of dividend and net buy back yield.
As a result, returns for equities should land between 6% and 7% for developed markets on a five-year horizon, and 10% for emerging markets.
For commodities, just to round out the major asset class, we’re expecting the aggregate basket to return somewhere close to 2% per annum on a five-year horizon.
HP: Well, thank you for giving us a comprehensive view. Let’s take these projections a step further and discuss asset allocation based on the refreshed assumptions. So, what implications do these projections have for the way we would strategically structure a portfolio?
LG: In a strategic way, not too many actually. With only very few exceptions, those being US government bonds and cash, return projections have been lowered across all asset classes and expect that risk has evolved in a proportional way, such as we don’t see a need to adjust the strategic asset allocation at this point.
One key variable for asset allocation on the risk side is the expected correlation between equities and bonds for the various regions. Along with the relative-return projections, this tells you whether equities and bonds are going to play the roles of substitutes or complements in a portfolio, and we’ve seen relatively high correlations expected between minus 0.2 and plus 0.1. Equities and bonds should continue acting more as substitutes rather than complements in a portfolio.
But this is strategic five- or even 10-, 15-year asset allocation and, in the end, this is just a blueprint for portfolio construction that needs to be put into action using products, and mainly to be tailored to specific investor requirements such as liquidity or the investment horizon. For example, it could make sense to take the regional divergence in fixed income returns into account when fleshing out this basic blueprint.
HP: Well, thank you, Lukas, for outlining the long-term landscape investors may find themselves in and what that could mean for asset allocation.
Let’s move on to the week ahead, where the focus will be on key inflation data from the United States and interest rate decisions in Sweden and Turkey.
Traders will await the Fed’s preferred measure of inflation on Friday, the PCE price index, which is expected to hold steady at 2.6%, at both the headline and core level. The core reading, in fact, is forecast to be the smallest increase since March 2021, according to Bloomberg data.
Markets will also closely monitor, I think, the accompanying personal spending figures following last week’s soft retail sales numbers. Sweden’s Riksbank and Turkey’s central bank are both expected to keep policy rates on hold at their current levels.
And with that, we’d like to thank you once again for joining us. I hope that you’ve found this update interesting. We will, of course, be back next week with our next instalment but, for now, may I wish you every success in the trading week ahead.
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