Multi-Manager People’s Perspectives

Central bankers haven’t helped the mood, emphasising the need to avoid the mistakes of the 1970s when monetary policy was eased too quickly, with central bankers later discovering that inflation was not defeated.

The economic data has centred around inflation data for the eurozone as well as the usual start of month PMI and ISM data. Data has illustrated that the decline in the pace of inflation remains volatile, with inflation in the eurozone unchanged in February at 8.5%, higher than expected; the pace of inflation in Spain and France actually accelerated last month. Core inflation (which excludes food and energy prices) climbed to a new record high of 5.6%. Markets are now pricing close to 150 basis points of further hikes from the European Central Bank this year. The PMI manufacturing data was slightly weaker than expected in the eurozone and remained in ‘contraction’ for the eighth consecutive month. In the UK, the PMI manufacturing data was ‘less bad’ than January but remained in contraction territory. The US ISM manufacturing data was just below expectations and showed the fourth consecutive month of contraction. The Chinese PMI data was a positive surprise, with the official PMI data (which has a bias to large companies and state-owned enterprises) at 52.6, well above the 50 level that separates contraction and expansion, and the strongest pace of expansion in a decade. The Chinese Caixin PMI data, which has a broader economic focus, showed the first expansion in 7 months. The strength of the Chinese data in January reflects the economic upswing from the abandonment of travel restrictions, quarantines, testing and lockdowns as China made a rapid exit from ‘zero Covid’.

It’s been another week in which central bankers have been busy telegraphing their hawkish intentions to financial markets. This comes as no surprise given the data highlighting inflation might be stickier than hoped for. In the eurozone, the Bundesbank’s Joachim Nagel said that the pre-announced 50 basis point hike for March “will not be the last… further significant interest rate steps might even be necessary afterwards”. In the US, the assumption has been that having downshifted to 25 basis point hikes, the Fed would continue on this path until rates reach their peak. But recent economic data has led to markets begin to price in a possibility of the Fed reverting to bigger hikes. Neel Kashkari of the Minneapolis Fed said “I’m open minded at this point whether it’s 25 or 50 basis points” while his colleague Raphael Bostic said “I think we will need to raise the Fed Funds Rate to between 5% and 5.25% and leave it there well into 2024…. History tells us that if we ease up on inflation before it is thoroughly subdued, it can flare anew; that happened with disastrous results in the 1970s”.

US markets are already pricing interest rates to reach above the levels suggested by Bostic, indeed the terminal rate this summer is now expected to be 5.5%. History shows rate cuts normally follow within six months of the peak rate, but it seems many Fed members see the outlook as different this time, with inflation proving stubborn in moving down towards the bank’s target. Andrew Bailey, governor of the Bank of England, echoed Bostic’s comments about the fears over a repeat of the 1970s, saying “if we do too little on interest rates now, we will only have to do more later on… the experience of the 1970s taught us that important lesson”. Bailey’s comment on the rates outlook was seen as a little more dovish however, as he said, “I would caution against suggesting either that we are done with increasing the Bank Rate, or that we will inevitably need to do more”.

It has been a quiet week in politics, but we did see a breakthrough in the long-drawn-out talks between the UK and EU on the Northern Ireland Protocol, which was part of the Brexit withdrawal agreement agreed under Boris Johnson’s government in 2019 and rushed through Parliament ahead of the legal date of Brexit. The Protocol was designed to avoid a hard border between Northern Ireland and the Republic of Ireland, which left Northern Ireland with access to the EU Single Market but in doing so created an effective border between Northern Ireland and the rest of the UK. This outcome left the Democratic Unionist Party (DUP) refusing to take part in the Northern Ireland Assembly, meaning the devolved government in Northern Ireland has not been functioning. Prime Minister Rishi Sunak met with European Commission President Ursula von der Leyen on Monday and agreed to reforms under the so called ‘Windsor Framework’ which will allow goods travelling between the mainland and Northern Ireland that are not bound for the EU to pass through a ‘green lane’ largely avoiding customs checks. This may seem like a minor technical issue but it has been a huge stumbling block in terms of Northern Irish political stability.

The Prime Minister hailed the agreement as a “new chapter” in UK-EU relations though of course the deal still needs Parliamentary approval, and the support of the DUP to allow the Northern Ireland assembly to re-start. DUP leader Jeffrey Donaldson said his party needed to go over the finer points of the agreement over the coming days but “in broad terms, it is clear that significant progress has been secured across a number of areas”. There is certainly some hope that with this deal, and the more conciliatory tone between Sunak and Ursula von der Leyen that the relationship between the UK and EU can be a little more constructive going forward. We shall see, but Sterling rallied on the news of a deal. Sterling now trades at 1.1276 to the euro; so there still a long way to go to the dizzy heights of 1.40 that we saw in the year before the referendum or indeed the even higher levels seen before the global financial crisis. But every little helps…