Volatility is back with a vengeance. It started in the bond markets when the Bank of England displayed its lack of unity on the Monetary Policy Committee (MPC) with a decision to leave rates unchanged so soon after the Governor had guided for an increase.
Most of the major central banks face a difficult dilemma removing their ‘emergency’ stimulus, having left the money pump running too long, but this sort of miscommunication is unforgivable. The sterling bond markets were thrown into disarray and liquidity (and trust) has suffered as a result. The UK ten-year Gilt yield, which had reached 120bps in late October sank back to 81bp. The next round from the Bank is 16th December, the date we had pencilled-in for the first 15bp rise in the base rate, as the Bloomberg Opinion Columnist, Marcus Ashworth, rather pithily put it “Donnez un grip”.
Of course, the uncertainty surrounding the latest COVID variation, Omicron, has thrown a further spanner into the works. The ECB also meets on 16th December and were supposed to be guiding as to the run-down of their support programme. Absent some more definite word on omicron, it is quite possible that both they and the MPC will use this an excuse to delay the decision again. The more important matter to look out for from the ECB is their forward ‘guidance’ on inflation, which needs to be rather more believable. Rather more significantly, Chairman of the Federal Reserve, Jerome Powell (thankfully re-elected), has just stated that the pace of their tapering should be sped-up, with the obvious implication for timing of the first US rate increase. Quite right, it is hard to see the need for emergency funding when US GDP is likely to have grown at an annualised rate close to 9% over the final quarter.
Chairman Powell also noted that it was time to move away from using the term ‘transitory’ to describe inflation, about time. US inflation continues to increase, reaching 6.2% in October, the UK rate climbed to 4.2% (6% on the RPI) and the euro zone November indication is 4.9%. None of which sits at all comfortably with the fall in sovereign bond yields, taking real yields to extreme (negative) lows. Something has to give, the only way to justify, for example, the UK 30yr gilt yield at 0.9% with inflation climbing is to assume that the central banks will tighten too fast, economic growth will slump back and we’ll all be back to pump priming again.
I suspect that a middle road is the more likely outcome. Bond yields are too low and should move up, while inflation will wane but not so fast and far as current bond yields indicate. Inflation will ease next year as comparisons move on from the lows of 2020 and, quite possibly, we may get some respite from the rise in energy prices. Against that, the labour market is strong and getting stronger, we suspect that the US unemployment rate could fall back to 1950s levels around 3% next year, with consequent pressure on wages as inflation expectations rise. Supply chain pressures will be exacerbated by new environmental border controls (CBAM etc) and a likely shift to more reliable sources (more local but more expensive).
The price of oil did appear to have been topping-out before the arrival of omicron triggered something of a collapse, it has fallen 18% since we last wrote. Encouragingly, the price of Natural Gas was also easing and has fallen further, now 34% below early October peak levels (I don’t think that I have heard the BBC mention that one...). Equity markets had been positive until the omicron news broke (rather unfortunately over the Thanksgiving holiday), after which they fell sharply. It would appear likely that risk assets will continue to struggle until we get more clarity on omicron. Hopefully, the early indications of this being a less harmful variant prove to be correct, we shall see. Happy Christmas.
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