Marlborough Monday Espresso Podcast - 20th June 2022

[00:00:00] Sheldon MacDonald: It is the 20th of June today. Last week was a particularly difficult week in markets.

[00:00:04] We saw deep declines in risk assets, pretty much all risky markets down, we'll come to China in the end though, that was slightly positive.

[00:00:13] But Western markets certainly taking the brunt of the downturn, and we have now tipped into bear market territory, especially in the US, the S&P on Monday reaching 20% below its previous peak and as I say, tipping into bear market territory.

[00:00:27] The big story of last week really was the central banks' raising rates. Nathan, can you give us
the background there?

[00:00:34] Nathan Sweeney: Yeah, so we actually had a number of central banks, increasing interest rates last week, all with the view to trying to reduce inflation.

[00:00:41] So we had the us central bank, they raised rates by 0.75%, which now has interest rates in the us at 1.75%.

[00:00:51] We had the bank of England, they were also as raising interest rates last week. So they raised rates by 0.25% and interest rates in the UK are now 1.25%.

[00:01:02] All of this activity, obviously the market doesn't like that because it could lead to a recession.

[00:01:08] Sheldon MacDonald: Yeah certainly policy error is the word on everybody's lips. Are they raising rates too far, too soon?

[00:01:15] But of course the central banks are saying by front loading, these rates, you end up with a better eventual outcome that may be getting a lid on inflation early, by going hard early like this, keeps inflation at a lower level than it would've reached otherwise.

[00:01:29] For the US, that's 75 basis points rise, that's the highest rate hike that they've had in well over 20 years. The UK now we've seen five rate hikes in a row.

[00:01:39] The ECB haven't yet raised rates, they did have an unscheduled meeting and certainly the tone after that meeting quite hawkish, they are ending their asset purchase program,so the end of quantitative easing in Europe, signaling that they'll start raising rates next month.

[00:01:56] Staying with Europe, some of the difficult questions now are what will happen to the periphery?

[00:02:02] Remember a good couple of years ago, people started getting concerned about the peripheral states. Will they be able to afford their debt costs at these higher rates? And that's certainly starting to become a concern. We are seeing the spreads widening.

[00:02:16] Coming back to the story about earlier rate hikes, giving us a better eventual effect. There is some indication that perhaps some of the rate hikes that have happened already are starting to bite.

[00:02:26] So in the us, we did see retail sales out and they come out lower than expected, Nathan your take on this?

[00:02:33] Nathan Sweeney: Yeah, so this is kind of counterintuitive. So we've got data which is weaker, which could actually be a positive because it means that the feed through to inflation is lower inflation.

[00:02:44] So we had a couple of data points last week. So as you mentioned, we had US retail sales, they fell by 0.3%.

[00:02:52] So that means that the consumer is retrenching in the face of inflation.

[00:02:56] You also saw that we had industrial production figures and we did have a slow reading on those figures for last month, and so that was the first time in four months that those figures fell as well as factory production.

[00:03:08] All that leads me to believe that actually that feeds through to lower inflation, which has the potential for central banks not to raise interest rates as much as expected.

[00:03:18] Sheldon MacDonald: And of course, one of the very powerful factors that drives inflation is actually inflation expectations.

[00:03:23] So if the central banks can put it in people's heads that yes, they are on top of it, they are going to be managing the situation and people do start expecting inflation, not to be as high as perhaps feared.

[00:03:35] That then becomes self-fulfilling, so there is some benefit in this view that going early might help things.

[00:03:41] Nathan Sweeney: And actually, if we look at the oil price for the week, the oil price fell 8.8%. As we know this has been one of the key drivers of inflation, higher oil prices. So it's good to see oil prices moving lower, and again, that's on recessionary fears because if you have a recession, you should have less demand for oil, but that will feed through, into lower inflation.

[00:04:03] Sheldon MacDonald: Of course, we'll be watching very carefully this week. Chair Powell of the fed, he'll be speaking a number of times this week, so people will be looking for the clues in what he's saying, trying to read what the fed might be thinking going forward.

[00:04:15] And of course, we'll get the PMI's, these are the purchasing manager indices. These are based on sentiment. These are surveys that are taken from factory managers and so on. And so they come out earlier than all the others. We don't have to wait until the data comes out. These factory managers are being surveyed all the time and it gives us the first and earliest clues as to what is really happening in the real economy.

[00:04:39] So those will be closely watched this week. We seeing those PMI out of the us, the UK, Europe, and Japan. And of course, we've got UK inflation as well.

[00:04:48] Now mentioned we'd come back to China. Nathan, China was one of the bright sparks last.

[00:04:54] Nathan Sweeney: Yeah. So actually the Chinese market was up last week, and this is contrary to a lot of the other developed markets, which were negative for the week.

[00:05:00] So why is that? Well, if it's, for a couple of reasons, firstly, we have property data, which was weaker than expected, which leads the market to believe that you will get more stimulus from the government.

[00:05:11] Secondly, we have lockdown restrictions which are easing, which should lead to less supply chain disruption.

[00:05:17] And actually we're seeing signs of that becasue industrial production or output from companies has increased, which will lead to less supply chain disruption.

[00:05:27] Sheldon MacDonald: So positive there, and just finishing on a last story, maybe not positive, but bonds pretty much flat last week, at least government bonds, the safe side of government bonds, and really just reflecting that the bond market had largely priced these rate hikes in.

[00:05:42] So the fact that bond markets not really reacting to the higher inflation numbers. Balanced by the fact that bond markets are starting to price in the potential for recession, really just the higher inflation balanced by those fears of recession. So bonds doing their job in the portfolio, providing some stability.

[00:06:00] Anyway, lots to look out for this week. Hopefully we get a better market and we see some stability returning, but all eyes on what will happen in the next few days.

[00:06:08] We'll speak to you again next week.

[00:06:10] Nathan Sweeney: Bye bye.