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Everything is transitory

By Henry Adams on 2021-09-17

As we head towards the final quarter of 2021, it is shaping up to have been a year of divergence. US indices continued to break records with earnings often beating expectations that were already set high, whilst on the other side of the coin the Hang Seng (Hong Kong) and CSI 300 (Shanghai) are sitting 9.5% and 7.75% cheaper (lower) than at the start of the year. At this point it might be prudent to take heed from the biggest and best regarded financial players including Goldman Sachs, Morgan Stanley, Citi, Bank of America and Deutsche Bank whose research teams are all calling the top and advising those managing money to reduce exposure to the Dow, S&P and NASDAQ as the quickest recovery in history may be about to unwind.

Where were you on the 15th of September 2008? For those operating in and around financial markets it was another September day that has been hard to forget. 13 years to the day since the collapse of Lehman Brothers it was announced that China Evergrande, the worlds most leveraged property developer, with a debt pile exceeding $300Bn, will be unable to make interest payments to domestic Chinese banks next week. Thursday saw trading in its bonds halted and we shall find out shortly how (dis)orderly the unwind will be. Why does this matter? As we have seen in the past, contagion and correlation are real and often not modelled well. With investors having chased yields as traditional jurisdictions saw erosion of credit spread following unprecedented stimulus, more overseas cash now sits in Chinese domestic assets than ever before. How that capital might fare in onshore insolvency/restructuring proceedings will be interesting to see…

Closer to home, Europe has also been on a good path of late with indices up and stimulus measures potentially being reduced sooner/faster. Whilst variants continue to create challenges along with the supply disruptions we are all well aware of, ECB President Lagarde, speaking to Bloomberg News on Thursday believes the region is recovering more rapidly than anticipated. The focus of the central bank and the broader economy should, according to Lagarde, be to bounce back in both digital and green fashion. Whilst this is indeed good news and a great ambition, those operating in the cash space continue to feel pain in the form of ever-more negative deposit rates with no end on the horizon. Further clarity or signs of relief did not come from ECB policymaker Rehn who stated that “rate hikes are not yet in sight but it will happen one day”. The Eurozone has not escaped higher inflation, terminology is different though, current elevated figures are being described as a “hump” that shall fall back in line in 2022.

In the UK growth, employment and inflation have all come in higher of late which has not gone unnoticed by central bankers nor the market. Recent data showed over one million job vacancies as furlough draws to a close, and GDP that has outperformed the rest of the G7 this year (albeit from a lower starting point after a bad 2020), having grown by 22.2% year-on-year in the second quarter of 2021. This leaves inflation which, much like everywhere else, does not want to go away. Just last week, comments from Governor Bailey sent the screens flashing, as he now believes the milestones have been reached to tighten monetary policy. Lock your mortgages in now!

Transitory inflation has been at the centre of Fed rhetoric in the US for some time now. Chairman Powell originally defined it as 1-3 months, later revising this to 3 – 6 months. Over the last 6 months inflation has sat comfortably above the Fed’s target of 2% and whilst the latest numbers did show a (marginal) decline in core CPI slowing to 4% from 4.3% (year-on-year) between July and August, US freight rates conversely rose the most in 15 years with the latest print at 26.6%. Reasonable people could certainly disagree about the difference between signals and noise in the abundance of conflicting current data. In US money markets we have seen record usage of the Fed’s RRP facility where participants can enter secured transactions with the Federal Reserve at 0.05%, When 5bps is so attractive that 82 major market participants place $1.19Tn with the Fed over August month-end, one can only conclude that the balance between the supply of money and the availability of productive opportunities to deploy capital has fallen out of equilibrium by quite some distance.

Other concerns when drilling into inflation numbers are that both food and housing costs remain elevated. Perhaps we should listen to National Bank of Hungary’s Deputy Governor and rate setter, Barnabas Virag, who on Thursday expressed that it would be a mistake to underestimate the risk of persistent inflation, stating that it is already rife, everywhere. Concerns are mounting that we may well be entering a period of the wrong type of growth and inflation, as prices continue to rise but labour data continues to show elevated levels of unemployment that may well be structural in nature and thus hard to cure. Stagnation risk looms… fingers crossed technology-driven growth comes to the rescue.

Across the board, the world of ESG continues to evolve with new issuers and structures entering the arena at pace as the financial world adjusts to a future that is better financed. Next week sees the launch of the UKs inaugural 10year benchmark “green” bond, the roadshow being kicked off by the Chancellor himself, noting that it represents the beginning of a green risk-free curve for others to benchmark against. It will be interesting to see how the market reacts and whether a “greenium” is applied, which will have far-reaching and positive implications if so. Elsewhere, ESG regulation in the US is drawing closer with the SEC reiterating that policy is coming and actions will be taken against those failing to apply rigour. In Europe, the backlash has already started with the German regulator looking at potentially punishing DWS for misleading investors in a space where metrics can be hard to measure. Its former owner, Deutsche Bank, on the other hand has printed the market’s first “green repo”, with the proceeds being directed to clean energy. There is, no doubt, lots more to come on this as the market strives for clear direction as to how best to measure and benchmark progress in this important and sensitive area.

Best Wishes
Henry Adams, Chief Product Officer

Articles of interest:

Treasurers hunt for yield as cash holdings return to pre-pandemic lows

Charting the Global Economy: Inflation Drumbeat Remains Steady

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