Global equities continued to grind higher last week, ending up around 0.5-1.0%, and have also opened higher this morning. Corporate earnings remain a major factor behind these latest gains with estimates for the third quarter reporting season continuing to rise.
The US tech sector led last week’s increases on the back of the earnings reports of the tech titans. While Apple and Amazon suffered from the global supply bottlenecks, these disappointments were more than made up for by earnings beats from Microsoft, Alphabet and Facebook (Meta). Echoing Google’s controversial renaming a few years ago, Facebook is now to be called Meta, in line with Mark Zuckerburg’s view that the future for Facebook and no doubt much of the planet lies in the ‘metaverse’.
Equities are now a little above their September highs and are taking a rather cooler view of the outlook than bonds, which have been jolted by many central banks deciding to accelerate their tightening plans. It is not only COP26 which is concerned about overheating and preparing to take action.
While the timing of rate hikes has been brought forward almost everywhere, the UK should be first off the mark amongst the major central banks, with the Fed second and the ECB bringing up the rear.
At last week’s ECB meeting, Christine Lagarde insisted that market expectations of a rate rise as soon as next year were misplaced. However, with inflation rising more than expected in October (the headline rate increased to 4.1% and the core rate to 2.1%), worries will very likely persist even if they ultimately end up being misplaced. We still don’t expect any hike before 2023 at the earliest.
Meanwhile, the US Fed looks all but certain on Wednesday to announce it will start tapering its QE program, with bond purchases coming to an end altogether by next summer. Much less certain is how soon after that it will begin to raise rates. A month ago, the central bank was split on whether it would need to raise rates next year. But since then, inflation worries have intensified and one or maybe even two rate hikes now look quite likely in the US in the second half of next year.
Friday saw news that the Fed’s favoured measure of core US inflation was unchanged at 3.6%. Yet beneath the surface, the report showed inflationary pressures spreading out from the outliers behind the bulk of the initial surge in prices. Furthermore, wage growth picked up considerably in the third quarter to 4.2%, the highest level in 20 years.
As for the Bank of England, a rate hike from 0.1% to 0.25% looks like a done deal, either at their meeting this Thursday or in December. The Budget, if anything, is likely only to have reinforced the Bank’s determination to make a move.
That said, the contents of the red box contained no big surprises and had little impact on the equity market or the pound. However, longer-dated gilt yields did reverse some of their recent jump, as debt issuance was cut more than expected.
The growth forecast for 2021 was revised up to 6.5% from 4.0% and the estimate of the long-term damage done to the economy by the pandemic cut from 3% to 2% of GDP. This in turn provided the Chancellor with a £35bn windfall which he duly went and spent.
Public spending was increased by some £37bn and is now forecast to remain close to 42% of GDP, the highest sustained level since the 1970s. Meanwhile the tax burden, despite the cuts announced in the budget itself, is forecast to rise to 36% of GDP in five years’ time, the highest since the 1950s. Still, the Chancellor has around £25bn leeway in hitting his new fiscal rules, which could come in handy for some pre-election tax cuts.
Market expectations that UK rates will be back up to 1.0% by next autumn, above their pre-pandemic level of 0.75%, look on the pessimistic side. All the same, with UK inflation on course to hit 5% in the spring and the labour market very tight, this can be far from ruled out.
The bottom line is that overheating worries are here to stay, one way or another. The risk near term is of a wage-price spiral while further out the danger is of a rather more profound nature.
Rupert Thompson
Chief Investment Officer