Musings on Markets (Dated 03/07/2022)

Markets continue to debate if growth concerns should overtake inflation concerns, and if central banks will be forced to backtrack on monetary tightening. Indeed, bond markets are currently pricing in a year end fed funds rate for Dec 23 of 2.65% in contrast to the FED’s dot plot showing 3.5%.

In the short term, it seems uncontroversial that the FED will continue with a 50bps hike in July, there is more substantial debate over September (50 v 25bps) & a particularly fierce debate over the path of rates over the course of 2023 (demonstrated by the divergence highlighted above). 

Powell commented on this ongoing debate at the ECB’s Sintra Symposium conference (27th – 29th June) stating that there was a risk that the FED’s rate hikes “may slow the economy too much” but that the bigger risk was letting inflation continue unrestrained.

A key determinant of the ability of Central banks to control inflation will be the degree to which it is demand led or cost push. On Friday we had an interesting set of Eurozone inflation data which highlighted that prices for energy and food were the main drivers of inflation, suggesting that eurozone inflation (perhaps due to its proximity to UKR) is relatively cost push led vis a vis the US – limiting the ability of the ECB to control inflation by raising rates & cooling demand.

Hopefully we’ll start to see some turn around as we head in 2023, as rate hikes take effect in cooling demand, and supply chains continue their post-COVID transition. However, as much as we might make progress within our own economies, there remains a very large external problem – Ukraine. As noted above, energy & food prices lead inflation prints, so the duration of the conflict will be a key determinant of the persistence of inflation.

In the immediate term it does appear that the sombre tone in financial markets (SPX -21% YTD) is starting to be reflected on the ground, and will start to prominently feature in company reporting, for example Zuckerberg was on record this week noting that Meta was cutting new engineering hires by 30%. However, with market sentiment heavily depressed some investors are starting to see value, with renowned investor Howard Marks commenting in the FT this week.

“We can never be sure, but this seems like a reasonable time to start buying. Things may well go lower. In that case, I hope we’ll have the will to buy more. It makes no sense to say: “I’m not going to buy until we reach a bottom.” We never know when we’re at the bottom, and certainly I’m not saying we are today. Only that things are a lot cheaper than they were a few months ago, and the values — such as the yields on bonds — are pretty good in the absolute. That makes this a reasonable time to start a buying program.”

You might note Howard Marks likely has substantial dry powder, which may not afford him to be as flexible timing wise as more modest investors.

In terms of Credit GBP, HY Corporates returned c.-184 basis points (bps) on the week, with Financials out-performing Non-Financials each returning c.-134 bps, and -195bps respectively. In terms of rating, Double BBs returned -195bps, whilst Single Bs and CCCs returned –165bps and -133bps respectively.

At time of writing (Fri 27th, Afternoon) The FTSE is down c1.5% on the week. GBP / USD is down 2% on the week at c.1.2021. The spread on the iTraxx Crossover (XOVER) – a proxy for the market’s assessment of credit risk (the greater the spread, the greater the perceived risk) increased by c.50ps over the week to 586.