On the agenda this week we have the prospects for US monetary policy after Jackson Hole, the outlook for the US economy ahead of the jobs report on Friday, and some better news on cases but tricky weeks ahead for the UK.
Tapering to start earlier than expected
Let’s start with US monetary policy. In his eagerly anticipated speech at Jackson Hole last week, the head of the US central bank indicated that they would start to taper the bond purchase programme before year end. That’s earlier than expected. But he also said that there was no read across to when they would raise the all important Fed funds rates. When he added that it would be wrong to raise rates in response to a temporary rise in inflation, the markets decided that the remarks were dovish, and equities hit new record highs.
Bottleneck shortages are temporary price pressures…
We think the markets are wrong about the prospects for the Fed remaining dovish, but agree that the outlook for risk assets remains positive. Yes, the Fed should hold their nerve in the face of temporary inflation pressures. They focus on core inflation to exclude volatile food and energy prices. In the unique circumstances of the recovery from the pandemic there are obvious bottleneck pressures, be they a shortage of containers that has boosted some shipping costs 10 fold, to high prices for used cars at auction. These are clearly temporary.
…but rising rents and wage inflation are more enduring
But evidence is beginning to emerge of more enduring price pressures. Shelter inflation – rents, the biggest component of consumer prices – has stepped up and is likely to continue to rise over the next 1-2 years. And wage inflation has begun to pick up sharply – it’s tricky to measure due to compositional effects (lots of low paid workers getting jobs reduces the average even as overall wage rates go up). It’s tough to disentangle the conflicting influences but all the measures that the Fed watches are rising. One more month of increases in wages and the Fed’s tone will change.
The market has a single hike in Fed funds priced in for the end of next year with one more in 2022. That’s far too dovish; I believe that they’ll be hiking within a year.
Equities have benefited hugely from low rates, so is the bull market is over?
The answer, based on past experience, is no: equities typical rally into a Fed hiking cycle and do well for several months after the first hike. The cast iron signal for an equity bear market is a downturn in the economy. And I don’t see that anywhere on the horizon. Indeed, the US is passing yet more fiscal expansion with two big infrastructure bills before Congress.
Better news on global virus cases but tricky weeks ahead for the UK
With more and more people vaccinated, the feed through to hospitalisations and deaths has been weakened. Living with Covid is the new normal. It remains a nasty disease, but lockdowns should be a thing of the past, barring a vaccine-escaping variant.
The UK led the way in terms of living with Covid but we are about to enter a tricky few weeks. The rise in new cases has flattened in England but continues to accelerate, albeit from a lower base, in Scotland. And that’s partly because schools in Scotland went back two weeks ago. With more mixing in pubs, more people back in the office, autumn approaching, and the requirement to self isolate severely reduced, new cases are set to rise. Yet economic data is also set to strengthen. I’m still bullish on sterling but feel rather nervous given the outlook.
All in all, we see continued economic recovery, led by developed markets; China continues to struggle economically. Equities should therefore continue to rally and bond yields rise. The pandemic is far from over, but we have entered a decisive new phase.
This weekly update is taking a break next week – I’ll be back on 13th September with my next update.
Past performance is not a guide to future performance. The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.
The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.