Investment Comment
16th December 2022
Synchronicity?
Both in the US and UK inflation came in lower than expected this week. There are realistic signs that peak inflation is behind us; inflation could trend lower through 2023 with deflation (falling prices) showing up in some sectors in the US. Whilst inflation pressures remain broader based in the UK, inflation does appear to be trending lower in coming months.
US inflation has peaked and indicators are that it should fall further in 2023.
Source: Artorius, Bloomberg
YOY - year-on-year comparison
After a year of near-zero rates in 2021, 2022 has seen interest rates rise across the board.
Source: Artorius, Bloomberg
US inflation has peaked and indicators are that it should fall further in 2023.
Source: Artorius, Bloomberg
YOY - year-on-year comparison
After a year of near-zero rates in 2021, 2022 has seen interest rates rise across the board.
Source: Artorius, Bloomberg
But peak interest rates can wait for now (at least in the US)
In the US the Federal Reserve raised interest rates by 0.5% on Wednesday to a range of 4.25% to 4.5%, with rates ending the year 4.25% higher than at the start. In the accompanying statement, the Fed repeated that "ongoing" rate increases are likely appropriate, indicating at least one more rate increase at the February meeting, and possibly also at the March meeting. This is higher than the expectations built into the bond market and suggests that the Federal Reserve remains hawkish, which appears to have dampened the risk appetite in equity markets.
The Federal Reserve Chair Powell’s comments welcomed the peak of inflation but cautioned that the labour market remained tight, so justifying the hawkish tilt in the projections for interest rates. He highlighted the need to bring ‘non-housing core service’ inflation lower before ending the interest rate tightening cycle. This narrowing of focus of inflation may mean that the deflationary pressures that are appearing in housing and used cars, where prices have started to fall, will be tolerated until the inflation pressures elsewhere have eased. If job losses can be avoided, then a decline in inflation will enable real incomes to recover in 2023, which would be an upside surprise for the US economy.
The flip side of a rise in real incomes is that this may come at the cost of profit margins. Through 2020-22, profit margins have been very strong, as prices rises have contributed to revenues growing more quickly than costs, in aggregate. The rise in profit margins has been a significant factor in corporate profit growth over the past 2 years.
Bank of England and European Central Bank raise rates
The Bank of England increased interest rates by 0.5% to 3.5% on Thursday. This was a split decision with one member of the decision-making group wanting to hold interest rates at 3% and two wanting to raise rates by 0.75%. Better than expected inflation data and a labour market in which vacancies are starting to fall may enable the bank to become less hawkish in 2023, especially if the UK housing market continues to slow with signs of house price declines showing up and a slowdown in transactions.
Across on the abandoned Continent, isolated from the recessionary British economy facing a winter of strikes, the European Central Bank, ECB, also raised interest rates 0.5% to 2% on Thursday. The ECB President was much more hawkish in subsequent commentary, highlighting that the ECB thinks that inflation may be prolonged despite the recessionary conditions in Europe.
2023 and beyond
Whilst the pace of interest rate increases may be moderating as inflation pressure peaks, the cumulative effect of the tightening seen to date is yet to be fully felt by the economy. An example of this is the delayed effect on the housing market, especially in the UK, of higher rates until more mortgage borrowers see their fixed rate deals come to an end and move to higher interest rate mortgages. This will eventually see more households face significantly higher interest costs and result in a slow down of consumer spending.
We suggest that although equity markets have fallen in 2022, the outlook for profits may mean the immediate outlook is challenging, but if valuations fall then prospective returns for investors should improve. As inflation peaks, so the pressure on bond markets may ease, so supporting longer dated high quality bonds over coming months. In time, lower bond yields provide a better valuation environment for other asset classes to make progress.
Football and celebrations
After Morocco’s success in the World Cup (football, thank God they don’t play cricket yet), not since Ingrid Bergman said “Play it, Sam”, has interest in Casablanca (released 80 years ago) been so high (is “play it again, Sam” the most misquoted film quote of all time?). Whilst Qatar may not have been everyone’s choice of venue, football has been the winner with many English fans having the difficult choice of supporting France or Argentina on Sunday.
As this is the last update of the year, I wish to thank our clients for their support and trust in 2022, and wish you all a Merry Christmas, or Happy Hanukkah and a peaceful 2023.
Gerard Lane Chief Investment Officer
Artorius provides this commentary in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 16th December 2022 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content.
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FP20221216001 EXP 27/01/2023