Hi everyone,

 

Earnings reports are coming in this week, and thus far we’re seeing a lot of companies beating expectations which has turned the markets largely green. However, the not-so-transient nature of the recent inflationary pressure has led the markets to price in more aggressive rate hikes. For instance, by the end of 2022, the markets are currently expecting the following…

• The Bank of Canada to hike close to FOUR times
• The European Central Bank to raise the deposit rate by 10bps
• The Bank of England will have taken the bank rate over 100bps
• The Reserve Bank of New Zealand to hike SIX more times

By extension, given current guidance, the above will have also meant that the ECB will have wrapped up its Asset Purchase Plan by then, while the BoE will have tapered and actively started to sell its gilt balances. But it’s likely a fantasy; none of the above will happen. Economic activity would come to an absolute standstill and risk assets (stocks) would get absolutely crushed. Of course, these projections aren’t without cause. There are three reasons why we think the markets have shifted in the way that they have:

 

i.) After months of being told by central bankers globally that the current rise in inflation is ‘transitory’, markets are picking up on a subtle shift in tone. You can only shift the goal posts on what transitory means for so long. BoE Governor Bailey’s remarks on Sunday were the final straw (in which he acknowledged that rising energy prices could creep into inflation expectations and that the BoE would have to act).

 

ii.) Smaller G-10 economies now have labour markets that have recovered jobs lost during the pandemic. Two of those central banks (RBNZ and Norges Bank) are hiking rates. The market is clearly testing the resolve of the others; including the BoC.

 

iii.) Central banks haven’t really pushed back. BoC Governor Macklem tried to last Thursday, but there wasn’t anything new or forceful there.

 

Eventually, markets will have to reckon with the fact that monetary policy doesn’t have to be (nor should be) aggressively tightened to address a supply shock. Add in the fact that debt burdens have increased across the developed world and it makes sense to bet on corrective moves in short rate markets. But we’ll need to be patient.

 

In other economic news south of the border, Manchin says that he’s not sure how a deal on Biden’s terms can be done by the end of the month. Axios reports that one of Manchin’s red lines is to include a firm work requirement and a family income cap of $60k (which would risk losing some progressive support for the bill at the margin). On a related note, Manchin met with progressive leader Jayapal yesterday for a few hours to lay out priorities for the bill. Yellen sent a letter to Congressional leaders informing them that extraordinary cash measures to stay under the Federal debt limit will be extended until December 3.

 

European markets are trading higher on gains in mining and technology shares supported by positive global sentiment. Investors have been aggressively pricing in interest rate hikes, mainly in the UK, to offset a rise in energy prices and supply chain shortages driving prices higher.

 

Markets in Asia-Pacific closed higher led by the tech sector with the Hang Seng Tech index in Hong Kong jumping 2.25%. China growth forecasts were downgraded at several brokers overnight following the weaker GDP as China's power shortages slowed growth, threatening global supply chains. A quick note on China’s real estate worries onshore. Many are forgetting that this is being engineered to a large degree by the central government and they can just as quickly reverse tack to take the pressure off.

 

Oil prices rose as Russia is limiting gas supplies to Europe and OPEC hasn’t pumped enough crude to meet its production target, fueling the supply crunch in energy markets.

 

As always give us a shout if you have any questions, or to book a portfolio review.

 

Stay safe,

 

Mike