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Blain: Its all about inflation, interest rates and wages…

Guest post by Bill Blain from his blog the Morning Porridge:

“Whom the gods intend to destroy, they first break their computer and disable their connectivity….”

This morning: As we approach US Thanksgiving – the start of holiday markets, the markets seem convinced we’re back on an upward path, but the reality is the new economic and inflationary cycle may only just have begun..

I think I must have upset someone up above.

Monday/Tuesday it was broken internet. This morning my company email has been blocked – I suspect why, but its frustration squared. The problem is without my email… how do I access the screeds and screeds of market commentary I need to help me fall asleep each evening…? I shall be drinking a lot of coffee this morning.

Nothing ever changes when it comes to dull, tedious market commentary – billions of words every day written to be read by compliance officers. Occasionally, you do find gems – beautifully crafted explanations of the form and substance of some part of the market that is critical to everything. But mostly its words. Lots of them. I suppose I am just as guilty.

There is loads of really, really interesting stuff going on. But in the absence of any emails since yesterday.. I’m just not sure what!

Listening to Radio 4 this morning I was wondering if I should use a spare couple of billion to buy Manchester United, load it up with loads of debt, sell off all the decent players, use “US Marketing” techniques to maximise revenue streams as an international franchise, and pay myself enormous dividends each year.

Oh. Wait. That’s what the Glazer family has already done.

Amusing to hear a US sports lawyer comment how US sports franchise owners think Global “Soccer” might potentially be an even larger market than NBL in terms of marketing and exploitation opportunities. Really? You think so? Just what is basketball? Sports… it’s a business.

Or how about the Eastern European Sub-Prime lending specialist “International Personal Finance” which has just launched a 12% “retail bond” aimed at UK savers. Alarm klaxons should be ringing loudly! 12% sounds a lot for taking a substantial risk, but when I were a lad on the syndicate desk of a US bank I remember launching Italian Lire bonds for reputable companies with double digit coupons. One of my first ever deals in the mid 80s was a Kiwi Dollar issue with an 18% coupon, and there may even have been some 20% plus deals, but I can’t remember the details as there was a velociraptor chasing me down Cornhill that day… (oh, the joy of being old…)

Yet, World Cup aside, I have to admit to being ever so slightly bored of all the market anticipation this week. I’m waiting for the penny to drop and for markets to realise they’ve been fooling themselves about all the positives of the US rate cuts…

What rate cuts you ask? – these will be the ones the market has convinced itself are coming… but which might not be..

Instead, it looks like we will snooze into tomorrow’s long US Thanksgiving holiday. (I reckon we should be celebrating Thanksgiving here in the UK: Thankyou Lord for allowing us to get shot of responsibility for these rude and crude colonials, but of course it’s a full working day.)

Maybe next week.. or maybe not.. the market will wake up to the grim reality of the Global economic crisis that’s festering upon or doorsteps, or the somnambulance of the Christmas slowdown that approaches?

Of course, we will do Christmas so much better here in the UK.. the true home of the absolutely ghastly Victorian Christmas we’re going to get in 4 weeks time…  This year it’s going to be properly Dickensian. Not only are there no Turkeys to buy because of Avian Flu, but even if you could find one you couldn’t afford to cook it.. Still, at least it will be cheap to hire genuine small, smiling cockney children to drop into the chimney, giving it a good sweep clean as they tumble down it. Bah Humbug you say.. but don’t mock it till you’ve tried it… (very small ones will fit in a woodburner I’m told..)

The OECD aren’t particularly hopeful on the UK’s prospects – saying we’re going to be the worst performing G7 Economy through to 2025. (Others reckon the UK will have slipped to G11 by 2025.) When I raised that issue with a client yesterday who also happens to be a major Brexit supporter – the response was not to deny it, but to enthuse how much worse it’s going to be in Europe. Sure. Someone really needs to develop a common sense vaccine…

What the stock and bond markets do next really depends on the two closely correlated aspects of the economy:

  • Inflation
  • Interest rates

The story we would like to hear is how Inflation is now set to fall as energy prices “normalise” on the back of the Russian Ukraine shock being mitigated by new supplies, allowing prices to ease, growth resume, and central banks to slow the pace of inflation fighting interest rate hikes, and eventually start cutting rates as early as next year. Other inflationary pressures from Chinese supply chain failures and Covid will also ease, and dollar strength will also lessen diminishing the effect of FX inflation on economies.

On the back of the better inflation outlook, consumers will become confident to start spending again, lower rates will allow corporates to borrow to grow, and stocks will become more attractive as Earnings per share recover and start improving. There should be an economic bonus from the brief period of economic austerity causing a productivity uptick.

Except such rosy predictions of recovery never really happen as expected.

The reality is noisy and messy.

The news out of China is not good. Rising Covid cases and new lockdowns. The scale of just how vulnerable China remains to Covid is not yet fully factored into markets.

Across the Occidental economies we are seeing increasing industrial and social tension as wage demands mount from unhappy workers convinced they are falling down the wages ladder. New rail strikes are described as industrial terrorism in the UK’s tabloid press – but what do you expect workers to do when they see inflation in double digits and clearly blame government incompetency for the crisis. It certainly doesn’t help public sector workers being held to low single digit wage rises when FTSE directors are seeing double digit pay increases.

Fighting inflation with interest rates means a fairly brutal approach to crushing wage inflation through job losses – but across Western economies there remains a shortage of available workers, and a political unwillingness to take the harsh steps required – especially in the UK which is effectively on an election footing already!

The markets are full of rosy expectations the worst of the 2022 market correction is already done and dusted, while the recent recovery in stocks reflects easing inflation pressures and upside to come as central banks declare the war on inflation done. A global recession can, perhaps, be shallow or even avoided.

If only…

Or what if this inflation battle has only just begun. Energy was the inflation trigger, but now its deeply entrenched in still broken supply chains and wage inflation – leading to many more serious issues for growth. Friday the 25th Nov is the 14th anniversary of the beginnings of QE in 2008 as the Fed sought to ease tensions in US markets post Lehman. It’s now clear it was the beginning of the most distorted markets in history – I’m hoping to write more about it on Friday – markets willing!

If you read one thing this week – check out of the BBerg story on Junk Carbon Credits – something I’ve been concerned about for a long while…

Guest post by Bill Blain from his blog the Morning Porridge.

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