A peep at the peak

For now, we seem to have reached close to peak rates across core markets. So now what? It’s likely to be a tale with several outcomes depending on jurisdiction, but primarily focused on growth and a region’s ability to keep the economic dream alive. With the velocity of hikes witnessed since the reversal of overly loose financial conditions, we remain cautious as this is historically where crashes have stemmed from. The only additional consideration, which is felt that the market is discounting as an outcome, is…another round of or persistent inflation.

Winter is coming. Expect a renewal of energy price rises. In the UK, petrol stations are already (again) becoming expensive places to hang out. At least all their forecourts are shiny and new. Argh. Then there is food and the geopolitical tensions creating potential scarcity of grain in particular but also, as more nations look to reduce or stop the export of necessities, price rises are again popping up in multiple pockets. The iconic iPhone, apparently a staple good that we all need, which, depending on the model, has jumped almost 10% in asking price. Oh, and if you need to charge your new headphones, add 12% to the cost of purchasing an adapter for your charger as these have not come as standard for some time. When Apple staff were questioned, the author was informed it is more environmentally friendly not to include. Unless the thing runs on ether, that argument just doesn’t stack up. Now you’ve just gotta pay. It’s not just Mars bars and bags of crisps that have been shrinking.

Troubles in China continue to bubble in the background, although one must wonder for how long it is possible to avoid a domino-like property collapse. Whilst new policies to avert disaster seem to be launched into the market weekly, solvency remains the name of the game. There are also reports of pay cuts of up to 40%, which will be difficult to swallow and unhelpful for consumption which is already wavering. The sovereign credit rating is something to continue to watch here, as domestic banks will suffer a blanket downgrade, as is tradition. Unhelpful here has been a shift in production back to domestic or neighbouring soil, in part captured below. Why is this interesting and relevant? Historically these exports have kept a lid on global inflation as the factory of the world.

In credit land, the recent rapid rise in interest rates has fuelled credit yields to levels not seen since pre-GFC. Meanwhile, worries about the prospects for economic growth in both domestic markets and globally, with China’s slowdown in particular, have brought equity yields lower. Hence we are seeing yield competition between the two asset classes for the first time in 16 years. The credit yield widening has been assisted by the second busiest August on record for new issuance, and September’s issuance to date exceeding what were already high expectations. Even if the new issue pipeline slows to any degree in the second half of the month, spreads will be supported by the ECB’s quantitative tightening, pumping €3.4bn of bonds back into the market.

Choppy is an understatement when it comes to predictions as to the ECB’s next hike. The beginning of the week saw a rounding error of the chance of a change. As the week went on though, traders piled into bets backing the eventual 0.25% hike.

In the end, fear of not containing inflation won. The more concerning news is growth. Projections were revised lower every year up to and including 2025. Read the next several years…Odds of stagflation? Up.

One thing that is certain. Inflation continues to persist; beleaguering recovery and affecting those more heavily indebted that would benefit most from a pause. It is a tough task to correctly manage monetary policy across 20 countries that enjoy setting their own, often different, and sometimes contradictory fiscal (or tax and spend) policies. Hikes are becoming less popular and more painful, so may be avoided from here on in. Although worse would be to once again let the horse bolt. Not a comfortable position to be in, which leads onto the UK as well…

Conflicting messaging from members setting rates at the Bank of England is keeping the market on its toes. Unemployment has risen (marginally) yet wage inflation for July has posted a record 7.8% rise. This wage inflation came in stronger and seems to be stubborn and persistent. Consumer price inflation continues to ease, still sitting at a lofty 6.8% in the year to July, but at least households, for now, are seeing real wages grow. The Governor has recently testified to the Treasury Select Committee, effectively reporting back to the government, stating that we are basically at peak rates. This is in stark contrast to MPC member Mann, who sees over-tightening easier to rectify than not moving. Sarah Breeden meanwhile believes much of the impact of tightening is yet to come through, but that the risk of embedded price rises remains elevated here, while Sir John Cunliff is more concerned with the fact that UK businesses have been slowing investment decisions.

UK mortgage arrears have risen dramatically, and whilst much of the burden has been reportedly taken on by homeowners, rents are soaring as landlords either leave the market or reprice to the new normal in borrowing rates. As per the Bank’s latest stats for Q2, arrears have risen 28.8% since the beginning of the year and in terms of value jumped £2bn from Q1 to Q2, best displayed graphically below.

Bank of England Mortgage Lenders and Administrators Statistics 2023 Q2

Rampant treasury bill issuance has not spoiled the market, with absorption hardly impacting price. The risk here is that funding continues to divert from banks, arbitraged away by various policies that have been stealing liquidity from the broader financial system. The Fed seems to be managing inflation down neatly though. Wednesday’s CPI numbers, although in part rising marginally, were a non-event for the market, coming roughly in line with expectations and comparatively low with CPI at 3.70%, although the rise for August represented the biggest monthly gain at 0.60%. Mostly driven by fuel (pardon the pun), the labour market appears to be holding up well with market sentiment currently strongest for one last hike of 0.25% in November. We shall see, as with the rest of the world, it can all change fast. Prudence is key.