Investment Comment
28th July 2023
Interest rates and profits on the rise
On Wednesday, the Federal Reserve increased interest rates by 0.25% to the highest level for more than 22 years, since before the Twin Towers terrorist attack. Since the start of the tightening cycle in March 2022 the scale of interest rate increases (5.25%) has been the largest since the early 1980s. Whilst there are pockets of weakness in the US economy, the resilience in economic growth has come as a surprise in the face of this monetary tightening. Given the backdrop of continued economic growth, the Federal Reserve Chairman may have surprised some in indicating that the Federal Reserve will wait for more data to decide on the next steps. With inflation coming in better than expected of late, the Federal Reserve is seeking to ensure that they don’t overtighten and weaken the economy unnecessarily.
The earnings season continues with about 50% of the US equity market reporting this week. The company updates reflect some of the mixed economic data. Easing inflation pressures are a two-way sword for profit margins and company profits, last year’s winners, i.e. energy companies, are losing in 2023 against better than expected releases from consumer facing names.
In the UK, the flurry of results reflects concerns around the UK banking sector with low deal flow and an increase in bad debt provisions curtailing profits. The winners are the likes of Centrica (British Gas) and Unilever where profits grew more quickly than expected, primarily on the back of price inflation rather than volume growth. Overall, company reports are slightly better than expected (in-line with the resilient economic backdrop), but the gap between winners and losers in a low growth environment grows.
Hotting up
Whilst the hot weather in Southern Europe captures the headlines, and the rain in Manchester dampens the soul, the weather rarely has a material impact on markets. But with a heightened awareness of climate change and a period of sustained exceptional weather patterns, this may change. Whilst the mild winter staved off the worst economic impact of the gas price rise, as a result of the Russian aggression in Ukraine, extreme heat is already being felt, with the hottest week on record for the entire planet at the beginning of July, following the hottest June on record according to the World Meteorological Organization.
One feature of reduced rainfall and hot weather through Europe has been the drop in river levels, threatening normal supply chains and energy supplies. The depth of the Rhine in Germany has fallen below 100cm, which makes the river difficult to navigate for fully laden barges carrying industrial goods. Likewise, the Danube has dropped which threatens a key European route for Ukrainian grain. The power production of French nuclear reactors has been cut due to high river temperatures along the river Rhone.
The Pacific is currently experiencing an El Niño event as a result of rapid and substantial changes in ocean temperature and the World Meteorological Organization (WMO) forecasts that there is a 90% probability of this continuing during the second half of the year. El Niño’s are typically associated with increased levels of hurricane activity (i.e. insurance claims) in the Northern Atlantic, but more settled conditions in Australia and Asian Pacific. El Niño has typically pushed food prices higher. Through 2023 emerging markets have benefited from lower food price inflation which has enabled some economies to cut interest rates. If El Nino disrupts this benign backdrop, investors may have to pay attention to weather forecasts as well as economic forecasts.
Gerard Lane Chief Investment Officer
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