Your weekly economic update from the team at FXD Capital
Stagflation is the word on lips at the moment as we enter Q4. While inflation expectations have ebbed between transitory and persistent, as lives are increasingly touched by inflation, it is the latter sentiment which is starting to prevail. It looks like the UK is set for a period of intense price pressure on everything ranging from energy prices to Christmas turkeys.
The COVID recovery bounce is drawing to a close and October in particular will be interesting as the dust settles from the furlough scheme’s curtain call. With buoyancy to the economy from reopening festivities concluding, the lights have been turned on and it turns out there’s a number of stains on the carpet. The supply shocks to petrol, food, HGV drivers, butchers and so forth is a structural issue, which will define the fortunes of the UK for the next generation.
An economy’s resilience and ability to pivot rests on the malleability of its workforce. Brexit and COVID together have exposed the UK labour market as being up the proverbial creek, sans paddle. Going back to Tony Blair’s time as PM, the past 30 years has seen swathes of young adults move to university and prepare for careers in the tertiary sector. In turn this has diminished the role of vocational training, permeated whiffs of snobbery towards service class careers and created a glut of supply within certain white collar sectors, for a group of increasingly debt-laden graduates.
Now without the steady stream of labour from Eastern Europe propping up supply chains, the UK faces a cruise ship turning moment, as opposed to ministers’ naive hopes of moped’s u-turn by throwing out a handful of three-month visa waivers. It will take years to redress imbalances in the labour market, both managing expectations of the labour itself and the demand for it.
The only silver lining to this, is perhaps this reckoning may arrive earlier for the UK. Importing labour to fill shortfalls and exploiting it with below market wages only works for so long. The EU works to this degree and eventually the music stops, in that there remain no more pockets of labour left! The goal for policymakers and business owners should be to make professions attractive through offering career paths, meritocratic environments and fair pay.
But returning to stagflation, what is fascinating (in a macabre kind of way) will be whether there is an inert will towards such a situation. With debt loads high across the board – ranging governments, corporates and householders – inflation helps erode the real cost of servicing such a debt, so long as the interest burden doesn’t cause a strain. Inflation without interest rate increases is the ideal situation for debtholders.
September was the worst month for bond and equity markets in 2021. Both the Federal Reserve and Bank of England appear to be finally acknowledging price pressure and indicating an appetite to raise interest rates. The 10-year UK Gilt yield pretty much doubled on the month from around 0.5% to 1.0% as investors sold off fixed income instruments.
USD is strong again as many investors predict that the Fed will be the first to raise interest rates, followed by the BOE and finally, the ECB.
The reflation trade from earlier in the year seems to be having a revival. As such commodity prices are en vogue and long-duration equities (i.e. technology) are not. It seems like the winter is going to be defined by energy prices, the combination of geopolitics and supply chain issues are the exact conditions which natural gas markets seem to thrive in.
It looks like interest rates have bottomed out and banks are now exercising more attention over the patronage of savers. Goldman Sachs’ Marcus notably increased its popular retail savings rate 0.1% this week.
Rates are rising, firstly due to the potential of base rate increases. As inflation approaches 4% (current long-term expectations are 3.85%), the chance of a rise accelerates. Futures price an almost 50:50 chance of the UK base rate moving up to 0.25% by the year’s end.
Secondly, as the post-COVID party ends, banks are increasingly looking to shore up their balance sheets. Perhaps the glut of liquidity has brought about complacency regarding the stickiness of deposits. But if prices are set to increase and costs invariably rise, deposits may be more fleet-footed. For banks, which have spent the past year underwriting everything under the sun thrown their way, ranging mortgages to SPACs, you can imagine that there may be some nervous ALCO meetings this autumn.
All the best for the week ahead
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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