BlueBay AM: A bad week for Boris, a worse week for hamsters

BlueBay AM: A bad week for Boris, a worse week for hamsters

UK
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By Mark Dowding, CIO at BlueBay Asset Management

More lockdown stories erode the credibility of the UK’s party-loving PM, while Hong Kong residents have their freedoms curtailed by zero-Covid policies.

Having risen sharply since the start of the year, global bond yields consolidated recent gains during the past week. US economic data is anticipated to show some temporal softness over the coming month, in the wake of the Omicron wave. Yet, this is not seen impacting the need for the Federal Reserve (Fed) to roll back policy accommodation, with markets pricing four hikes through the course of 2022. 

Next week’s meeting should convey a change in language as the board preps markets for a first hike in March. With this fully discounted, it is not clear that this will be a material catalyst to drive yields much further in the near term. Meanwhile, growing risks of imminent conflict in Ukraine have also been a factor weighing on risk sentiment. 

Ultimately, there seems very little that the West can do about Russian aggression, given European dependence on gas imports. Putin is well placed to achieve whatever aim he chooses to fulfil at this point, in the knowledge that rising energy prices may self-fund any conflagration that takes place.

Notwithstanding these shorter-term concerns, we continue to see yields trending higher in the medium term. If the Fed is intent on bringing rates above neutral in this cycle, then this would infer Fed Funds reaching 2.75% or more in 2023 or 2024 – well above market expectations.

We doubt that inflation concerns will be quick to dissipate due to ongoing supply disruptions from China, as Beijing continues to try to maintain a zero-Covid policy. April CPI data (released in May) will see inflation figures fall as base effects drop out of the reading. However, we think that underlying price pressures may be rising as inflation expectations de-anchor.

Consequently, inflation will likely remain well above target at the end of this year. Notwithstanding any policy tightening in 2022, real interest rates should remain negative come December. In this context, we think that policy will only have become less accommodative, rather than restrictive, in 12 months from now. From this standpoint, we think that more hikes will be needed next year, and it is in 2023 and beyond that our views with respect to policy tightening diverge more materially from what markets are discounting.

 

We believe that wage inflation may be a hot topic in 2022. In this context, it was interesting to see news from the UK this week that refuse collectors on the south coast have been awarded a 20% pay rise spread over the next two years. 

Trade unions have noted how members have suffered a reduction in pay in real terms over the past year. There is a sense that they will be happy to resort to industrial action in order to drive eye-catching pay gains in the months to come, helped by relatively tight labour markets and an inelasticity of labour supply. Companies we meet with note that, notwithstanding modest price increases in 2021, input costs have risen much more rapidly than retail prices. From this standpoint, it was noteworthy to see Germany PPI inflation at 24.2% in this week’s data release. 

Subsequently, we are hearing of plans to hike retail prices further in 2022 in order to protect margins, after price hikes in 2021 have been absorbed without any loss in market share. At a time when aggregate demand exceeds aggregate supply in many sectors, companies need not fear competition, in the knowledge that there is not the spare capacity to meet demand.

Against this backdrop, hiking prices has become a less risky strategy for many companies. Meanwhile, where consumers are captive, it may be possible to push through material hikes. In this context, it was noted that Tottenham Hotspur Football Club has raised prices within its stadium for the second time this season. But then, it could be said that prices are the only thing on the way up at Spurs!

UK inflation surprised with RPI hitting 7.5% this week. In the coming months, regulated prices, which are linked to this measure, will also jump and it seems clear that secondary inflation effects are becoming more prevalent. This will see the BoE turn more hawkish at its upcoming meeting in February, especially with the labour market robust and the country continuing to make progress away from the pandemic. 

Similarly, we also see increased hawkishness at the ECB in the coming months. An end to asset purchases by the end of 2022 may make for a challenging backdrop for eurozone assets and with political uncertainty increasing, there may be some pressure on the eurozone periphery in the next few months.

Equity indices have had a challenging start to the year, as rotation sees ongoing weakness of high PE stocks relative to value sectors. This has fed into corporate credit spreads at a time of seasonally heavy supply. We have participated in relatively few deals on the basis that we see limited scope for spread compression, given the broader macro backdrop. 

That said, a robust economic outlook continues to underpin credit quality and in a low yield environment, we would anticipate cash on the sidelines being put to work if there is a material dip.

Meanwhile, in EM, Russia worries have continued to see a number of assets trade on the back foot. However, policy easing in the wake of slowing growth has helped assets in China. Sentiment may improve if Beijing can demonstrate its intent to support growth going forward, though it may still be premature to think that issues in the real estate sector have reached their peak.

FX markets were relatively quiet during the past week. The Rouble traded with some volatility but there were few decisive moves elsewhere with price action contained within existing ranges.

Looking ahead

Next week’s Fed meeting will provide the main focal point. Without a press conference or updated forecasts, markets will scrutinise the wording of the press statement. Yet we doubt this will contain a lot of new information relative to what has already been communicated in recent comments. In the absence of firm data or Fed action, we could see yields consolidate for a time, before resuming an uptrend as Omicron passes and the Fed prepares to hike rates as we move towards March.

Elsewhere, we continue to wait to see how long Boris Johnson can last as UK Prime Minister. Recent revelations with respect to Downing Street partying in the middle of lockdown have been very damaging to the Prime Minister and we sense that it won’t be too long before his party gives him the push. This could have come earlier, but there may be a sense that potential candidates would rather take the helm once the pandemic is in the rear-view mirror, as we think will certainly be the case before the spring. Indeed, the body language from Boris appears to suggest that he knows that the game is up and he may soon be a dead man walking. 

That said, if it has been a bad week for Boris, spare a thought for the hamsters of Hong Kong, facing extermination in the name of the latest Covid crackdown. 

With the regional government equally enthusiastic to lock up its residents in shipping containers in Penny Bay, the outlook for Hong Kong appears pretty bleak and one wonders whether talented human capital will be actively selecting to migrate to jurisdictions determined to have managed the pandemic well with few disruptions (Dubai, Florida, Texas being possible examples), relative to autocratic regimes demonstrating little regard for personal freedoms.