Multi-Manager People’s Perspectives

Treasury Secretary Janet Yellen reiterated the urgency of the situation, saying it was “highly likely” the Treasury will run out of cash by early June. While both sides of the political divide have been talking up prospects of a deal, the likelihood of negotiations going down to the wire has begun to weigh on sentiment, even though the expectation remains that a deal will be reached – not least thanks to more positive comments that have lifted market mood in the past couple of trading sessions. 

Both President Biden and House Speaker Kevin McCarthy have been expressing optimism over reaching an agreement, but there is still the possibility of a short-term extension, or more negatively a government “shutdown”, if the Treasury runs out of cash. The Treasury reported a cash balance of $49.5 billion yesterday, which sounds significant, but the pace of decline from $120 billion two weeks ago shows that the US is on a path to running out of cash. A default is not technically allowed by the constitution so further financial engineering may be needed to ensure interest payments on government bonds are still made. All the same, the fact that a 21-day Treasury bill – more or less the safest asset around – saw an auction this week with a yield of 6% does indicate  that markets are pricing some risk of disruption.

The last time any US government bond yield had a yield of 6% was back in 2000. President Biden said that “default is off the table and the only way to move forward is in good faith toward a bipartisan agreement”. The content of any agreement will be a significant influence on US growth in the coming years – 2011 is our guide here with more than $1 trillion of spending cuts needed to reach a bipartisan agreement. Such a drop in spending back in 2011 caused a collapse in expectations for the economic growth outlook and things would be no different this time – not ideal when there is already a recession on the horizon.

There have not been any central banks meeting this week, but there have been plenty of central bankers speaking, reminding markets that inflation has not yet been tamed. In the US, Federal Reserve (Fed) Chair Jay Powell said economic data “supports the view that inflation progress will be slow” and noted the “highly uncertain” impact of tighter credit conditions. James Bullard of the St Louis Fed said, “I think we’re going to have to grind higher with the policy rate”, with his thinking being “two more moves this year”. The European Central Bank has also seen members speaking out, with President Lagarde saying that while inflation “is beginning to go down”, rates still need to be “sustainably high” with “more delicate decisions ahead”. Pablo Hernadez de Cos, Bank of Spain Governor and ECB board member, observed that “the process of monetary tightening is already well advanced … we still have some way to go; we anticipate that rates will have to remain in restrictive territory for a long time to reach our target in a sustained manner”.

Turning to economic data, the flash PMI numbers were published this week and once again highlighted weakness in manufacturing across the US, UK and eurozone. However, continued strength in the services sector means that composite PMI data points to overall growth despite the ongoing contraction in manufacturing. The Japanese data was notable not just for manufacturing moving into “expansion” territory for the first time in seven months, but the services numbers were at the highest level on record.

In Germany, a revision to first quarter GDP data from 0.0% to -0.3% meant a technical recession has taken place following a contraction of 0.5% in the final quarter of 2022. The weakness in manufacturing contributed to the decline, as did a significant drop in household and government spending. The UK reported inflation data for April, and while this showed a notable drop from March it was still higher than expected. UK CPI in April was 8.7%, down from 10.1% in March but higher than the expected 8.2%. Most concerning was the Core CPI data, which excludes food and energy prices, which climbed from 6.2% year-on-year in March to 6.8% in April, an all-time high. This gives weight to the Bank of England’s concerns that while goods inflation is easing, price pressure in the services sector is now driving inflation, and putting upwards pressure on wages.

Base effects will help push the headline level of inflation lower over the coming months, but the persistence of inflation looks to be a problem. Food inflation at 19.1% will continue to prolong the “cost of living crisis”. Highlighting the positive impact of base effects, electricity, gas and fuel prices were up “only” 24.3% year-on-year in April compared to 85.6% year-on-year in March. Bank of England Governor Andrew Bailey told MPs that “there are risks of persistence” in the inflation data, while his colleague Catherine Mann noted that “tightening [of policy] and tight are not the same thing, observing that “real rates are still negative”. Real rates – the difference between the interest rate and inflation – will converge at some point this year but markets are now pricing a higher level of base rates from the Bank of England, with rates now expected to peak at as much as 5.5% before the Bank pauses.

Some positive news for the UK came from the International Monetary Fund (IMF), which upgraded its growth forecast for 2023 to rule out a recession. The IMF expects the UK to see growth of 0.4%, having predicted a contraction of 0.3% last month. So, what’s changed? IMF Managing Director, Kristalina Georgieva, said the upgrade to the UK outlook was driven by falling energy prices, a more pragmatic approach to Brexit and improved financial stability. She noted “decisive and responsible steps taken in recent months” but highlighted “considerable risks” with the biggest danger from “greater than anticipated persistence in price and wage setting”. The IMF sees growth of 1% and 2% in 2024 and 2025 respectively, and inflation not falling to the Bank of England’s 2% target until mid-2025.

If you go back a few years, elections in Greece would have been a major drama for European markets, but the general election last weekend took place almost without anyone noticing. The incumbent (and business friendly) New Democracy party secured 41% of the vote – short of an overall majority to form a government alone but still in a very strong position. The party will likely opt for another ballot in four weeks’ time to secure a majority rather than form a coalition. This option has been ruled out by all the main parties, including the left of centre Syriza party of former PM Alexis Tsipras, which took second place in the vote with 21%. Greek assets responded very positively, with bonds and equities rallying. The Athens Stock Exchange was up over 6% on Monday, while Greek government bonds rallied to such an extent that the Greek 10-year bond now has a lower yield than the equivalent bond from the UK. After the worrying inflation data this week, UK bonds are touching levels seen in the aftermath of the Truss/Kwarteng mini budget. How times change.

I’ll be taking a few days off next week for the half term holidays so the next update will be Friday 9 June. Fingers crossed that the recent sunshine continues!

Kind regards,

Anthony.