Mixed Signals On Inflation

Global equities edged some 0.5% lower last week, leaving them down 3.3% in local currency terms over September. In sterling terms, the decline over the month was reduced to a modest 0.3% by the weakening in the pound against the stronger dollar.

Meanwhile, bond yields continued their recent upward march, rising 0.1-0.2% last week. 10-year US Treasury yields hit a new high of 4.6% whereas UK gilt yields still remain a bit below their summer peak.

The recent rise in yields has been mainly a result of the market waking up to the fact that rates are unlikely to be cut any time soon and has occurred despite the better-than-expected inflation data of late. The UK numbers two weeks ago were the biggest surprise and were behind the BOE holding off on another rate hike.

But Eurozone inflation also undershot expectations in September, with the headline and core rates falling from above 5% to 4.3% and 4.5% respectively. The Fed’s favoured measure of core US inflation also made pleasant reading on Friday. A modest 0.1% increase in August reduced the rise over the year to 3.9% from 4.2%.

Still, the oil price is doing its best to counter this good news. The Brent price tested $97/bbl last week and is up over 30% from its summer low. The boost coming from the recent decision by Saudi Arabia and Russia to extend their production cuts to the end of the year has been reinforced by firm demand which has drawn down US stockpiles more than expected.

While central banks primarily focus on core inflation, which strips out food and energy, the rise in oil prices is still likely to be viewed with some trepidation. Petrol prices are highly visible and their renewed rise could help drive inflation expectations up again. Headline inflation in the US, which hit a low of 3% in June, has been moving higher again subsequently and could well end the year around 4%.

The recent retreat in equities has been driven mainly by the spike higher in US bond yields. But there has also been some concern that US growth, which has held up surprisingly well so far, was set to slow sharply this quarter. Student loan payments, which had been paused during the pandemic, are now being restarted and there is also the drag coming from the ongoing strike by the auto workers union.

Still, one potential hit to growth has been averted, at least for now. A shutdown of the US government had been looking set to start this weekend but was averted at the last moment. However, the stop-gap funding agreement expires in mid-November and a shutdown later this quarter remains quite likely with Democrats and Republicans still far apart on their government spending plans.

Here in the UK, the latest GDP numbers made quite pleasant reading. Following hefty upward revisions, the statisticians now believe the UK economy was 1.8% larger in the second quarter than pre-pandemic at the end of 2019. This now exceeds the growth of 1.7% in France and 0.2% in Germany seen over this period.

While this still leaves the UK trailing by a sizeable margin the 6.1% growth seen in the US, the UK economy no longer appears quite the basket case implied by the dirt-cheap valuations of UK equities. Indeed, helped by the bounce in the oil price and the belief that interest rates have now peaked, they have been outperforming again in recent weeks. The UK remains one of our preferred markets.

Rupert Thompson – Chief Economist