Week ending 20th May 2022.

Global equity markets have been on a roller-coaster ride this week, as the market appears to be waking up to what we have been arguing ad-nauseum about for months:  that significantly higher interest rates won’t bring down inflation but will hurt economic growth.

This is because the current high inflation is not a result of excess demand.  It is a result of supply-chain disruptions and the war in Ukraine; and while we accept inflation will hang around for the rest of the year, it is likely to fall during 2023 on its own volition without the need for central banks to aggressively increase interest rates, due to what is known as ‘base effect’ – as the price increases we are experiencing this year will fall out of the next reading’s calculations.

Consequently, significantly higher interest rates across the world won’t be good for the global economy, as the sharp jump in energy costs and elevated food prices are already constraining our disposable income – not to mention April’s tax increase.  And as we have previously explained, higher interest rates won’t make oil come out of the ground any faster, or harvest more crops.

Additionally, given the fact that the consumer accounts for around 60% of the UK economy, and two-thirds of the US economy, higher interest rates will only further reduce our consumption and thus slow the global economy (or worse, put it into reverse), as higher interest rates means higher debt repayments.

If central bank policymakers needed any evidence of the mounting pressures on households in the real world, it was clearly provided in this morning’s (Friday 20 May 2022) UK Consumer Confidence reading, which came in at its lowest level since records began in the 1970s – meaning consumer sentiment is today lower than it was at the height of the global financial crisis in 2008/9 and the recession in the early 1990s, when unemployment rose to over 10%.

We are also seeing the impact of this squeeze in a number of companies reliant on consumer spending.  For example, in the UK, Greggs, the pasty and sausage roll retailer, said that it was seeing its costs starting to rise and warned that it may not be able to fully pass on these costs without seeing demand destruction given the pressure customers are already under; while the furniture retailer, Made.com warned that sales have started to weaken as consumers have become cautious about committing to large purchases.

It was a similar story in the US as both Walmart and Target said that while food sales had held up well, sales in their more profitable non-grocery/general merchandise lines (such as electrical appliances, toys, clothes, garden and DIY products, etc) had disappointed.

While we fully understand and appreciate that the current equity market volatility is unpleasant and unnerving, it is very important to remember that markets often tend to overshoot on both the upside and downside and so it is best not to get caught up in the day-to-day noise of the market as that can lead to rash decisions, but instead maintain a long-term perspective.

Looking ahead to this coming week, the main event will be the release of the minutes of the last Fed monetary policy meeting (which was held on 4 May 2022), given the obvious signs that economic growth is slowing.

Data wise, it is a relatively quiet week.  Of main interest to us will be US, UK & Eurozone CPI; US durable goods; and US housing data.

Investment Management Team