Will He or Wont He?

Weekly Update 21 February 2022

This week has been another volatile week for global markets as the stand-off between Russia and Ukraine and its western allies continues. There is much speculation about whether Russia’s President Vladimir Putin will order an invasion of the Ukraine or whether this is just grandstanding to stop the possibility of Ukraine joining NATO. We don’t know for certain but I suspect (or hope at least) that it’s the latter, especially as the Ukraine joining NATO is most unlikely, given it’s the ‘Northern Atlantic Treaty Organisation’ whilst Ukraine lies in the Crimean Peninsula. However, Western leaders continue to talk up the threat and it gives them an opportunity to distract their own populations and the media from their own domestic scandals and economic problems.

In the UK the country braces itself for Storm Dennis following the recent disruption caused by Storm Eunice. However, there’s another storm brewing, the constitutional storm surrounding the Prince Charles’s Princes Trust being investigated for cash for honours and his younger brother, Andrew, settling an accusation of sexual assault out of court. Combined with the geopolitical storm of the potential for the first major invasion in Europe since the Second World War and the political storms surrounding the Prime Minister, you could say it’s been a very turbulent week indeed.

In 1987 similar events were accompanied by a stock market crash when the US and many other major stock markets sold off 35% with Black Monday coming the day before strong storms hit the UK. This year, Storm Eunice has been heralded by a sharp correction in US equities, but as the latest market fall was only 10% let’s hope the impact of this week’s multiple storms are of a smaller magnitude and length.

  GLOBAL: EVENTS SURROUNDING UKRAINE DESTABILISE MARKETS

As mentioned, it has been another volatile week for global equities as the stand-off between Russia and Ukraine and its western allies continues. Asset prices have risen and fallen as the tone of diplomatic exchanges has moved from conciliatory to aggressive and back, and each side has accused the other of disinformation causing investors to move from positive to extremely defensive positions very quickly.

US tech stocks have seen some of the biggest moves, rising faster than most developed equities at the beginning of the week on news of further diplomatic efforts and the statement by Moscow that it was withdrawing troops from the Ukrainian border, but then falling sharply towards the end of the week on the news of skirmishes in Eastern Ukraine and President Biden’s warning that an invasion is still imminent. European equities have also seen some dramatic single day movements and developed market equities are all set to close the week lower. In contrast, major government bonds have been steadier this week, with UK gilts (seen at times like this as a safe-haven) rising in value.

MARKETS PREPARE FOR QUANTITATIVE TIGHTENING

The period since the great western banking crash of 2008 has been characterised by strong, but bumpy bull markets in bonds and equities. The have to a great extent been assisted by large scale interventions from the leading central banks – creating money and buying financial assets to maintain low interest rates and market confidence high.

The central banks have been able to do this because they are required to hit targets for general inflation and for many years inflation has remained low.  But you will have seen our thoughts in last weeks newsletter about their role in all of this, – the message to the public versus what perhaps is really going in here.  There has been plenty of asset-price inflation but market participants thought this was a god thing but there is always a price to pay this such artificial stimuli.

The sheer scale of what the central banks have done is astonishing. The big three central banks, the US, the ECB and Japan – have themselves alone bought a total of US$Trillion in financial assets (effectively buying back (clearing) the debt of the governments they work for – if only we could all do that!). The UK adds another £895Billion to that huge total. The effect has been to purposely drive interest rates down on longer dated borrowings wjhich is another way of these out iof control governments managing their debt.

The message to the markets is that these central banks want credit to be cheap and easy. Zero pretty much became the norm during the pandemic.

China, the second largest economy, incidentally saw no need to take such action with it’s central bank having no good reason for any quantitative easing.

Proportionately, the US Federal Reserve injected the most, – and consequently has the most elevated inflation problem as a result. It is ending it’s QE this month and has embarked on a programme of rate rises to bring down inflation and slow the demand for credit. It is now debating if and when it should start quantitative tightening to reduce the size of its balance sheet by selling some of the securities it bought in QE. Isn’t that handy? Hey have already sold them once, and then paid off their creditors via QE, so they can sell them again to raise more money!  And these people are entrusted to run our lives?

The European Central Bank (“ECB”) has been slower to reverse it’s present accommodative policy. It is ending its special pandemic bond-buying programme next month, but only to replace that with more buying of bonds by its previously established Asset Purchase Programme, which is expected to run at 40Billion Euros per month in the second quarter 2022, reducing to 20Billion a month by the end of 2022.  This will drive Eurobond prices down as support is withdrawn and rates are increased.

Across the US, Europe and the UK, we might expect to see the slowing of the economies as the hit to real incomes from higher prices (inflation) limits non-essential purchases.

MARKETS PREPARE FOR QUANTITATIVE TIGHTENING

The period since the great western banking crash of 2008 has been characterised by strong, but bumpy bull markets in bonds and equities. The have to a great extent been assisted by large scale interventions from the leading central banks – creating money and buying financial assets to maintain low interest rates and market confidence high.

The central banks have been able to do this because they are required to hit targets for general inflation and for many byears inflation has remained low.  But you will have seen our thoughts in last weeks newsletter about their role in all of this, – the message to the public versus what perhaps is really going in here.  There has been plenty of asset-price inflation but market participants thought this was a god thing but there is always a price to pay this such artificial stimuli.

The sheer scale of what the central banks have done is astonishing. The big three central banks, the US, the ECB and Japan – have themselves alone bought a total of US$Trillion in financial assets (effectively buying back (clearing) the debt of the governments they work for – if only we could all do that!). The UK adds another £895Billion to that huge total. The effect has been to purposely drive interest rates down on longer dated borrowings which is another way of these out of control governments managing their debt.

The message to the markets is that these central banks want credit to be cheap and easy. Zero pretty much became the norm during the pandemic.

China, the second largest economy, incidentally saw no need to take such action with it’s central bank having no good reason for any quantitative easing.

Proportionately, the US Federal Reserve injected the most, – and consequently has the most elevated inflation problem as a result. It is ending it’s QE this month and has embarked on a programme of rate rises to bring down inflation and slow the demand for credit. It is now debating if and when it should start quantitative tightening to reduce the size of its balance sheet by selling some of the securities it bought in QE. Isn’t that handy? Hey have already sold them once, and then paid off their creditors via QE, so they can sell them again to raise more money!  And these people are entrusted to run our lives?

The European Central Bank (“ECB”) has been slower to reverse it’s present accommodative policy. It is ending its special pandemic bond-buying programme next month, but only to replace that with more buying of bonds by its previously established Asset Purchase Programme, which is expected to run at 40Billion Euros per month in the second quarter 2022, reducing to 20Billion a month by the end of 2022.  This will drive Eurobond prices down as support is withdrawn and rates are increased.

Across the US, Europe and the UK, we might expect to see the slowing of the economies as the hit to real incomes from higher prices (inflation) limits non-essential purchases.

GEOPOLITICS

There appears no end in sight to the Ukraine-Russia crisis in sight. Warnings from the US administration that there is evidence on the ground that Russia was moving towards an imminent invasion of Ukraine rattled markets. Ukraine have accused pro-Russian separatists of attacking a village near the border, and Russia’s increased military presence does seem to mimic Russia’s playbook ahead of its 2014 illegal annexation of Crimea which sparked international uproar and triggered sanctions against Moscow. Although the situation in Eastern Europe is hitting markets, both sides insist that they do not want a war, – although we are rather more inclined to believe the Ukrainians on that assertion than we are the Russians at this juncture judging by their military manoeuvres and build up along the border which appear to be very much in attack mode.

  UK: INFLATION HITS IT’S HIGHEST LEVEL SINCE 1992

The UK Consumer Prices Index reached 5.5% in January and remains considerably higher than the Bank of England’s (BoE) 2% inflation target. The main contributors were transport costs and housing and household services, although transport costs are showing signs of slowing. The BoE has predicted inflation could rise above 7% in April 2022 when the UK’s energy regulator Ofgem increase the default energy tariff price cap.

Retail sales have remained robust as figures this week show sales increased 1.9% in January reaching their highest level since the reopening of non-essential stores last April. Some economists have predicted that high inflation together with the strong labour market increases the likelihood that the BoE will continue to rise interest rates more aggressively. Not good for borrowers and only adding to inflation, but welcomed by savers.

However, data out this week shows that despite record job vacancies inflation outpaced wage growth in the final quarter of 2021. Average weekly earnings grew at an annual pace of 3.7% but rising inflation caused overall real wages to fall 0.8%.

   COMMODITIES: DESPITE UKRAINE TENSIONS OIL PRICES EASE

Oil prices also had another volatile week as ongoing concerns about the tensions between Russia and Ukraine drove prices up. The international benchmark Brent Crude rose to $96 per barrel to reach its highest level since 2014. However, prices started to decline following reports that Opec+ is working to shape a deal that will revive the 2015 Iran nuclear deal that could potentially bring back 1 million barrels of oil a day back into the market.

The prospect of Iranian oil returning to the market outweighed the fears of potential supply-chain disruptions from a conflict between Russia and Ukraine and Brent Crude has fallen to $91 per barrel since. Although oil prices are declining, some analysts have predicted that they will hold between $90 to $100 per barrel as geopolitical uncertainties and a tight global market, driven by supply-chain restrictions and demand recovery continue to keep energy prices elevated.

If you enjoy reading this weekly update, please feel free to share it with your friends and / or family who may also find the contents of interest, and do not hesitate to contact us if you need any help, information or advice yourself about any of the areas covered this week.

Yours sincerely,

Phil Simmonds