With plenty of headlines during the week devoted to the U.S. elections, Sterling’s fall (of which more below) and a potential shortage of Marmite (don’t ask), it would be easy to have missed the news that the Chinese Producer Price Index (PPI) turned positive in September for the first time since early 2012. The index is a measure of factory-gate prices and economists suggested the pick-up was driven by gains in coal and copper prices amid a government push to scale back overcapacity. The slow but continual weakening of the Chinese Renminbi has also been a factor, with the exchange rate recently having broken the 6.70 level against the U.S. Dollar. The release of the PPI number coincided with the announcement that headline Chinese consumer price inflation accelerated from an annualised rate of 1.6% in August to 1.9% in September. Given the close link between producer prices and export prices, it raised hopes that China might soon stop exporting deflation to the rest of the global economy. It’s also a potential sign that global deflationary fears are fading, which would be welcome news for most of the world’s major central bankers. Feedback we received from the recent International Monetary Fund (IMF) meetings in Washington suggested that policy makers were watching Chinese PPI with interest, noting its recent improvement. Some in Washington believe that this improvement could spill over into global inflation numbers, and potentially alter many policy and rates assumptions. In a number of previous blogs, we have expressed our view that headline inflation rates could soon start to pick up, as last year’s fall in oil prices drops out of the calculations. Over the coming months, the inflation figures should see a rising oil price compared to this time last year, and this effect may push inflation higher. We also believe that the inflation protected securities offer good value at present levels. We are beginning to build positions in inflation markets that should benefit from this anticipated pick-up in headline inflation rates.
2. IMF Debriefing
Each autumn, the IMF and World Bank hold their annual meetings. Two out of every three years, the meetings convene in Washington and the third year is hosted by a member country. Around these meetings, the Bank and the IMF organise a number of forums to facilitate the interaction of governments and World Bank-IMF staff with civil society organisations, journalists, private sector executives, academics and representatives of other international organizations. It’s a kind of Woodstock or Glastonbury for financial market economists, who get face time with senior politicians and central bankers. This year a major theme at meetings was the realisation that the “low low” world of low growth and low rates has stoked a populist backlash that is now evident in many countries. Prior to Brexit, this “low low” state was not seen as having any significant political implications. Now, as one commentator so eloquently put it, “Brexit and Trump may yet be to developed market politicians something equivalent to Lehman for the financial system.” Politicians being what they are, and well used to sniffing out the mood of the electorate, that means a shift to a more fiscally expansionary stance that aims to diffuse this populism over time. The most obvious example has been in the UK, where Prime Minister Theresa May has claimed the Bank of England’s (BoE) strategy has damaged the interests of savers, pensioners and the young. This sparked a furious response from BoE Governor Mark Carney, who insisted he would not “take instruction” from politicians. Either way, May has signalled a move towards higher fiscal spending. In Europe, Spain is delivering 3% growth with deficits of 5%, allowing the centre-right party PP to see off their socialist rivals. Even Germany is discussing increasing its defence budget from 1.2% to 2% next year, as well as tax cuts. And in the U.S., both Presidential candidates are advocating higher government spending. Increased fiscal spending means bigger budget deficits that need to be funded by increased issuance of government bonds. That, in the long-term, may lead to higher bond yields.
We noted in last week’s blog that Sterling had been having a tough time. It really didn’t get any better last week, with the Pound continuing to depreciate against other major currencies, most notably the U.S. Dollar and the Euro. Everything seems to be going wrong for Sterling at the moment – UK Prime Minister Theresa May is embroiled in an unseemly spat with her central bank Governor Mark Carney about the conduct of monetary policy, the Scottish National Party leader Nicola Sturgeon announced plans to hold a second referendum on Scottish independence, and PM May faces a High Court challenge to her contention that Article 50 can be triggered without parliamentary approval. At one stage last week, it looked like UK supermarkets would stop stocking Marmite – a peculiarly British food spread, due to disagreements between the manufacturer and stockists about who should bear the cost of Sterling’s depreciation. On top of that, the UK runs “twin deficits” – a nasty economic combination of a current account deficit and a budget deficit. Positioning data indicates there are record short positions in the UK currency, and given the extent of the depreciation, some investors think Sterling could be due for a bounce. Unfortunately, it’s really a matter of confidence in the short-term – talk of a “hard Brexit” mean investment decisions are postponed, leading to capital repatriation or outflows. These can only be stemmed by intervention or rate hikes, neither of which is a palatable option for the UK authorities. Therefore, we are in uncharted territory – nothing like Brexit has occurred in the past so we have no guidelines to what might happen next. The further the currency depreciates the more likely a short-term corrective bounce becomes but right now, it’s difficult to build a convincing argument for a strategic long Sterling position.