Daily Comment (January 5, 2023)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EST] | PDF
Good morning! Today’s Comment begins with our thoughts about global central banking. Next, we discuss why political uncertainty in the U.K. and the U.S. may impact investment decisions within these countries. Lastly, we review the challenges companies may face when navigating in a less globalized world.
Monetary Moderation: Although financial conditions will likely remain tight around the world, interest rates may peak later this year.
- The Federal Reserve wants investors to know that it is not ready to take its foot off the pedal in the fight against inflation. The Federal Open Market Committee (FOMC) meeting minutes released on Wednesday showed that policymakers are concerned that financial markets are prematurely pricing in an interest rate cut. As a result, the FOMC emphasized that policy easing would not start until inflation fell to its 2% target. Additionally, it warned that unwarranted easing in financial conditions could complicate the bank’s efforts to restore price stability. That said, policymakers seem inclined to keep their next few hikes at 50 bps or lower in their upcoming meetings.
- Although policymakers support keeping the policy rate in restrictive territory, some members are open to a pause. Minneapolis Fed President and notable hawk Neel Kashkari said that he would like rates to rise another 100 bps before the central bank halts its hiking cycle. Based on the market projection of rate increases, this could mean that the Fed could be finished with its hiking cycle in July at the latest.
- China’s central bank reiterated its commitment to maintaining a relatively loose monetary policy in order to promote economic growth. The People’s Bank of China will use its monetary tools to ensure ample liquidity as the economy transitions from Zero-COVID. The country is determined to stimulate growth, and it has already loosened restrictions on property lending and is considering fiscal stimulus. So far, the monetary easing has not boosted household consumption, as consumers are still reluctant to engage in service activities while COVID spreads. Although the country’s latest inflation reports showed CPI rising 1.5% from the previous year, the additional stimulus may prop up inflation down the road.
- Meanwhile, a sharp deceleration in inflation has helped push down bond yields for European countries. The yield on 10-year German bonds fell for the fourth consecutive day on Wednesday, its longest streak since November. Italian bonds also performed well with the yield gap between German and Italian debt, a gauge for financial stress within the Eurozone, narrowed to its lowest level in three weeks. Although the decline in inflation will not prevent the European Central Bank from hiking rates in its next meeting, it does signal that the central bank will not need to be as aggressive to tame inflation as policymakers originally thought.
Populist Uncertainty: The U.S. and U.K. are finding it increasingly difficult to form a government that can satisfy the needs of all the varying party coalitions.
- The U.S. House of Representatives failed to select a new Speaker for the sixth consecutive vote. Although Republicans have a majority, a few holdouts have refrained from choosing Congressman Kevin McCarthy for the position. The constant jockeying from the far-right politicians for more influence within the party may be a bad omen for worse things to come later in the year. For example, if the Republicans can’t agree on something as simple as the Speaker, how are they supposed to agree on a budget? Although situations like this should make reaching across the aisle more appealing, political polarization makes that option costly for lawmakers, and therefore unlikely to happen. As a result, debt default due to a refusal to raise the debt ceiling cannot be ruled out.
- In the U.K., Prime Minister Rishi Sunak has come under scrutiny for not articulating a clear vision for the country going forward. The country is currently undergoing several crises, from rising work stoppages to crumbling National Health Services, as well as an imminent recession. To address these concerns, Sunak has made a five-point pledge he outlined as the peoples’ priorities. The pledge includes: a cut in inflation by the end of the year, growth in the economy with a decrease in the national debt by the end of the current parliament, a cut to the NHS waitlist, and the passage of stringent immigration laws. If Sunak were to fail to make good on these promises, his premiership could be in jeopardy.
- Although many of the goals are achievable, the first two could be difficult to accomplish. Inflation is expected to be more persistent in the U.K. than in other countries and it is expected that the next recession will be worse than the pandemic downturn.
- The political divergence reflects the toll of the growing polarization within these countries. The last time that the U.S. failed to elect a Speaker of the House was in 1823, and the event served as a prelude to the Civil War. Meanwhile, Brexit still divides the U.K. as the country has yet to figure out its identity going forward. Although it is unlikely that populist elements will be able to take firm root within these governments any time soon, political disruptions are likely to become normal. As a result, investors should pay closer attention to regulatory threats that immigration, free trade, and tech will pose to their investment portfolios within these countries.
Great Powers at Play: As the war rages on in Ukraine, companies are beginning to adjust to a world divided by blocs.
- Despite the recent success of Ukraine, there are still concerns that Russia could stage a comeback. NATO Secretary-General Jens Stoltenberg has warned members not to underestimate Russia. Meanwhile, a possible new mobilization push by Russia has led Ukrainian President Volodymyr Zelensky to ask for more military assistance from the West. The rise in concern has led allies to pledge to send more military equipment. However, the additional aid for Ukraine increases the likelihood of a prolonged war.
- In an attempt to end the conflict, Turkish President Recep Tayyip Erdoğan has urged Putin to declare a ceasefire to pave the way for peace talks.
- Additionally, companies are starting to diversify their supply chains in order to adapt to a less predictable world. Apple (AAPL, $126.36) has already shifted some of its operations out of China in favor of India and Vietnam. The trend was also reflected in a 2022 survey that revealed that the ratio of executives expressing concern about the political risk in China had jumped to 20-1, compared to 2-1 two years prior. As companies look to rearrange their supply chains, it could lead to higher global inflation but could benefit countries that don’t align with either bloc.
- MSCI Asia ex-Japan is trading near a four-month high and is set for its fourth straight day of gains. Although much of the growth is related to China’s relaxing of its Zero-COVID restrictions, we suspect that other countries within the index could also benefit in 2023 as companies look to reshore their operations in nearby countries. The size of India’s labor force and its neutral status could make it an investment target, and therefore, bears watching. Indonesia could be another country of interest due to its natural resources.