Flirting with recession but so far avoiding it  

As the UK shivers in what is hopefully winter’s last hurrah with half the country under a blanket of snow, at least in January the economy avoided contraction: month-over-month GDP grew by 0.3%, reversing the negative number from December and indicating that on a rolling quarterly basis, economic growth was about flat. We are flirting with recession, but we are not in one. Meanwhile in Germany, inflation data for February remained static at 8.7%, having shown an unexpected rise in January; this can be taken two ways depending on your point of view: good news that it did not rise again or bad news it did not come down.  

Experts divided  

This has been a topsy turvy week for markets. As the economic soothsayers variously poke chickens’ entrails and read tea leaves in a vain attempt to establish what is going on, the policy makers at the central banks are just as much at sea. And they’re supposed to be the real experts, the visionaries, when it comes to synthesising all the data and making sense of it in pricing the cost of borrowing! This week saw Jay Powell, Chairman of the Federal Reserve, making one of his regular submissions to the Senate, while here in the UK, a member of the Bank of England’s Monetary Policy Committee (MPC) was on manoeuvres flying kites ahead of the forthcoming rate-setting meeting.


Step back and look at the essentials behind what led them to very different answers to a superficially common problem. Compare and contrast: inflation in the US is 6.4%, US GDP is under 1%, unemployment remains below 4%, the debt to GDP ratio is 137%, interest rates are 4.75% and Powell thinks the medicine is not strong enough, conditions are too buoyant still and interest rates are likely to have to go higher than markets wanted and remain elevated for longer than hoped; contrast with the UK where inflation is 10.1%, GDP is below 1%, unemployment is below 4%, debt/GDP is 97%, interest rates are 4.0% and MPC member Swati Dinghra says UK base rates should rise no further. Can both be right?


The reality here is that Chairman Powell is maintaining the Fed’s “higher for longer” narrative and is ‘on message’ with his committee (there might be robust debate and some who are bound to disagree with the conclusions in the rate-setting discussion, but Powell’s own conclusion is hardly a surprise however much markets might balk at hearing it); Dinghra on the other hand, while not a lone voice wanting to stay interest rates, is in a small minority at the Bank of England, making her mark as a new member of the MPC and in this case indulging in wishful thinking or mischief-making. Thanks to the Fed’s gravitational pull and the dominance of the dollar, it is quite difficult to have significantly diverging rates of interest in the UK without putting strain on the currency. Currency traders follow the money margin: as the interest rate gap widens between the US and the UK, they sell sterling and buy the dollar. For the UK, as a significant net importer of goods, a weaker currency creates inflationary pressure, precisely the opposite of what the Bank is trying to achieve. But at the root of these divergent opinions is the debate as to how much economic pain is needed and is sustainable, particularly in the context of the significant levels of debt still sloshing around the system and the money that is spent servicing it, in order to return inflation to the mandated target of 2% common to the US, the eurozone, Japan and the UK.  

Barometric bonds: deepening low pressure over the Atlantic  

As ever, the barometer is the bond markets. The aftermath of Powell’s testimony saw old milestones being revisited (note we are most definitely not using the hackneyed and over-used term ‘unprecedented’ because these are most certainly not unprecedented): pre-occupied with near-term funding costs as markets interpret that US rates might now peak closer to 6% than 5% with all the risk to the economy, the US yield curve continued its inversion with short-term yields being increasingly higher than long-term. At one point the 2-Year Treasury breached 5% for the first time since 2007 before the Great Financial Crisis, and the differential between the 2-Year and the 10-Year exceeded 1.04%, a gap not seen since September 1981 (before a significant proportion of today’s market participants were born; this author had just left school).


As it is, we will soon know the outcome of those central bank deliberations: the Fed meets on 21-22nd March, the Bank of England MPC on 23rd and the European Central Bank for the eurozone on 16th. A point of debate in the lead-up to the Fed’s meeting in the context of Powell’s comments this week is whether having toned down the aggression last month by deploying only a quarter percentage point rise, the Fed continues with more of such increments for longer, partly to save face, or resumes with half or (less likely but not impossible) three-quarter point rises to get the job done quickly but in doing so effectively admits that the February decision was wrong. Presentation or pragmatism? Time will tell.


To the extent there is anything much to talk about that has not already been trailed by Jeremy Hunt, we will comment on the UK Budget next week.


The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.  

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