Investment Comment
14th November 2022
Peaky?
Good news at last on the inflation front, with US inflation for October coming in below market expectations and giving tangible evidence that inflation in the US has now peaked. Consumer Price Index (CPI) rose 0.4% in October, below the consensus expected +0.6%, while core CPI, which excludes food and energy, rose 0.3% in October, below the consensus expected +0.5%. CPI is up 7.7% from a year ago, while core CPI is up 6.3%. Now, both of these numbers are clearly still high and well above the Federal Reserve’s long-term target of 2% but there are good reasons to believe inflation will fall back from here.
Headline and Core inflation look like they’ve peaked
Source: Bloomberg
YOY - Year on Year comparison
The market reaction to this data was uniformly positive with investors pricing in a lower peak for interest rates and increasingly the likelihood of a “Fed pivot” (the point at which the Fed shifts from raising rates to cutting them). Equities and bonds both reacted strongly, with the S&P 500 up over 5% on the day.
While undoubtedly good news, we would be cautious in extrapolating too much from this data. The market has consistently been too optimistic about the path of interest rates and the Fed has only recently reiterated its hawkishness and the need to keep rates at a higher level to tame inflation. Investors may once again be disappointed. Also, the impact of interest rate rises on the economy is lagged and we are increasingly concerned that the cumulative effect of tightening policy will push the US and global economy into recession.
Holding back the red wave
Tuesday saw the US mid-term elections, with all seats in the House of Representatives and 1/3 of Senate seats up for grabs. The Democrats have controlled both the House and Senate for the last 2 years, which has allowed President Biden (to some extent) to fulfil his domestic agenda. That was widely expected to change with a Republican “tsunami” forecast that would lead to them taking both. Results are still being counted and it seems Democrats have done better than expected. The top 2 issues voters highlighted were inflation and abortion. The latter, following the Supreme Court’s overturning of Roe v. Wade earlier in the year, seems to have energised Democratic supporters to get out and vote.
Nevertheless with 20 results still outstanding it seems likely that the Democrats will lose the House of Representatives, which will effectively end Biden’s domestic agenda. However, the Democrats have held on to the Senate. While control of the Senate will not help Democrats enact their domestic agenda it will still enable them to make appointments, including Supreme Court nominations should one become open. At the time of writing on Friday it looked like the Senate would boil down to a run-off election in Georgia next month, but with the Democrats holding on to Arizona and Nevada that will simply be the icing on the cake.
Markets generally like mixed governments because a lack of total control prevents either party from doing anything too extreme, and in many ways reduces uncertainty. The potential risk could be that the Republicans try and play hardball on the US debt ceiling, which relies on a congressional vote and is sadly a recurring event. That could lead to a government shutdown and, at the extreme, the risk of a US default. While unlikely, it’s been a crazy year in politics.
Gareth Thomas Head of Investment Management
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FP20221114001 EXP23/12/2022