Investment
Comment
3rd March 2023
Good news
After an ebullient January, markets retraced some of the positive moves in February. Inflation appears to be remaining higher for longer, both in Europe and in the US. This has resulted in Central Bankers reiterating their belief that interest rates will need to be raised through 2023. As this message has filtered through to investor mindsets bonds and equities have eased back through February.
US economic data is mixed. After the interest rate increases of the past two years, US housing market indicators are at levels consistent with recessions. Despite this backdrop, employment conditions remain strong and continue to register employment growth of between 2-3% depending on the measure used. Wage inflation of 5% supports consumer spending, and if this continues then the Federal Reserve is likely to continue to raise interest rates. A case of good economic news implies bad policy news, especially against the backdrop of inflation remaining higher than previously expected.
The Federal Reserve meeting at the end of March may provide a focus for markets given the risk of higher for longer both in terms of inflation and interest rates. This would dampen risk appetite in the face of uncertainty around corporate profitability.
UK Budget thoughts
Ahead of the UK budget on March 15th, it is worth highlighting that the UK economic outlook is brighter than thought possible after budgets in the Autumn. The UK can now expect a shorter, shallower economic downturn than expected in the Autumn, and borrowing this year and next could come in around £30 billion lower than forecast in November, owing largely to lower energy prices and interest rates than previously expected, and stronger-than-expected tax revenues.
A big problem for the government is the wave of public sector strikes where the pay restraint over the past decade combined with the high inflation of the past year has resulted in significant real-term pay cuts for public sector workers. According to the Institute for Fiscal Studies (IFS), unlocking public sector pay disputes will almost certainly require extra funding from the Treasury. As it stands, departments can ‘afford’ pay awards of at most 3.5% in 2023–24.
The Treasury does not object to higher public sector pay awards solely on the grounds of affordability, however, it also argues that higher awards risk exacerbating current inflationary pressures. Given the absence of market prices in public services such as the NHS, it is difficult to see how a higher public sector pay award could directly trigger a ‘wage–price spiral’, in the sense that paying nurses higher salaries will not directly result in higher prices for patient treatment by the NHS, unlike the private sector where wage increases do tend to get reflected in higher prices (or lower profit margins) charged by companies.
Budgets tend not to be market moving events, but as the Truss-Kwarteng Budget (fiscal event) shows shocks can happen, but one hopes that the Budget on the 15th March passes with minimal impact.
Gerard Lane
Chief Investment Officer
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