Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
Inflation may be peaking in the US, as evidenced by US producer prices, but is also increasingly apparent at a consumer price level in the US. As a result, markets have responded positively, and logically, in that they are pricing a slightly faster reduction in US interest rates. This has led to assets experiencing a broad-based rally, while the US dollar has weakened. The much anticipated ‘Fed pivot’ is in play, even if Fed members are keen to reign in overly optimistic market expectations.
As we have argued previously, we think it fanciful to believe that inflation, and therefore rates, will quickly fall to, and then stay at, pre-Covid levels. This is because there are some relatively new forces that are now dominating the inflationary environment, most importantly deglobalisation and resource supply constraints, both of which are inflationary.
As an example, take semiconductor chips, which are the lifeblood of many industries and one of the most traded products globally. New US chip export controls, intended to stymy Chinese progress in artificial intelligence and advanced military equipment, will likely decouple this complex global supply chain and apply upwards pricing pressures.
As a result of the inflationary environment, we believe that interest rates will stay at relatively high levels, even if they peak in June of next year, as markets currently expect. Indeed, markets still have US rates at about 4.7% by the end of 2023, above current levels, and above levels all the way back to 2007. All of which adds to the accumulative impact of high rates. The source for these US rates estimations is Bloomberg as at 25.11.2022.
So, even though markets are embracing the Fed pivot, we think it’s important to remember that rates will most likely remain at relatively high levels for an extended period. Importantly, something normally breaks during a Fed hiking cycle, and certainly big tech and crypto have come under pressure, but the longer rates remain elevated the more areas come under more pressure.
US inflation and rates are of course most relevant for financial markets but economies, and therefore their monetary policies, are increasingly marching to different drumbeats. Take the UK, for example. Then consumer price inflation looks much stickier than in the US, even if UK producer price inflation has shown signs of rolling over.
In terms of damage, the scale and duration of UK inflation means it is applying increasing pressures beyond the first-round effects on profit margins and consumer spending, specifically through days lost due to strikes.
The graph below looks at strikes in the UK over history. There are similarities in context to the 1980s and now, such as unions demanding higher pay rises to keep pace with inflation.
Source: Office for National Statistics data to September 2022
However, for several reasons, such as introduced legislation and reduced trade union membership, we don’t expect a return to levels seen in the 1980s. Nevertheless, working days lost due to labour disputes in the UK are close to a ten year high and spreading across industries, while pressure on nurses and teachers to strike remains. This will apply both economic and political stress and will unlikely dissipate as soon as we get a peak in UK inflation.
In short, just because inflation in the US may be peaking, it doesn’t mean that the difficult period for markets, economies and politicians is drawing to an end. Furthermore, the damage is not consistent globally. We highlighted above the divergence between US and UK inflation, but in Asia inflation has generally been much less elevated, with producer price inflation in China actually moving into deflationary territory last month. These divergent economic performances increase the opportunity for portfolio diversification, especially for flexible global multi asset funds.
