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The relentless upward trend in equities has continued with markets edging higher last week. Global equities are now some 2.3% above their September high in local currency terms and a rather larger 4.7% in sterling terms.
The latter has been boosted by the recent weakening of the pound, which has fallen back to $1.34 from highs last spring of over $1.40. A good part of this decline has reflected a strengthening of the dollar but some is also down to domestic UK issues.
Stagflation worries are if anything greater in the UK than elsewhere. Brexit is also now back on the worry list, with talk of the UK invoking Article 16 of the Irish Protocol which would risk a more general trade confrontation with the EU.
Meanwhile, any support from the Bank of England bringing forward its tightening plans proved short-lived following its failure to raise rates earlier this month despite heavy hints that a hike was on the cards. Even so, the Bank still plans on raising rates in coming months. While the market has scaled back its expectations somewhat, it continues to price in rates up at 1% by next autumn.
One reason why the prospect of rising rates has not bolstered the pound is that tightening plans have also been accelerated in the US. The Fed has now started scaling back or ‘tapering’ its QE program, with bond purchases set to finish altogether by next summer. Furthermore, the latest inflation news means the first rate hike now looks likely to occur soon after QE has drawn to a close.
Headline US inflation hit 6.2% in October, the highest level since 1990, and core inflation (excluding food and energy prices) also rose to a 30-year high of 4.6%. Importantly, the figures showed a further broadening out of inflationary pressures beyond the outliers behind the initial surge in prices.
US inflation now looks set to remain well above target well into next year and for considerably longer than the Fed had been anticipating. Market expectations, which are now for two US rate hikes by the end of next year, look quite plausible.
US bond yields have risen as a result but not as much as might have been expected. At 1.52%, 10-year US yields remain some 0.2% below their highs earlier in the year. This relatively benign reaction by bonds is partly why equities have been able to continue their upward trajectory.
We also had news out last week on the health of the economic recovery. The UK GDP numbers were rather a mixed bag, with activity rising a larger than expected 0.6% in September but the gains in July and August revised down. GDP currently remains some 0.6% below its pre-pandemic level in February 2020.
Elsewhere, Japanese GDP was unexpectedly weak in the third quarter. It fell 0.8%, confirming that Japan is seeing the weakest recovery of any of the major economies. Much more importantly these days, the latest industrial production and retail sales numbers pointed to Chinese growth (which has recently slowed more than expected) bottoming out.
This all leaves until last a comment on the event which is least important for markets short term but most important long term. COP26 can maybe best summarised as representing a small but inadequate step in the right direction.
After much handwringing, the agreement did include a reference to coal but only to ‘phasing down’ rather than ‘phasing out’ its use. There were other pledges as well, including one to cut methane emissions although major emitters such as China and India did not sign up. China and the US also agreed to cooperate on emission cuts but there was little progress in setting a global carbon tax.
In short, the goal of limiting climate change to 1.5 degrees is not yet dead but is very much on life-support.