End June 2022

With The Queen's Platinum Jubilee long weekend and Glastonbury now behind us, and all things tennis from Wimbledon ahead, the summer beckons.

June is nearly over, and at the same time, the squeeze on household budgets has really started. The news headlines are full of economic comment, but the main issues are inflation at over 9.0% (9.1% Consumer Prices Index (CPI) / May 2022, the highest for 40 years) and the National Insurance increase of 1.25% (with a partial offset for some starting in July owing to an increase in the starting threshold). With another reset of the energy price cap due in October 2022, we are now also starting to see £2 a litre at UK petrol pumps, which is placing financial pressure on most home finances. The Bank of England and the Office for Budget Responsibility expect UK inflation to reach 11.0% in the last quarter of 2022, before holding close to this rate, then falling back in 2023, perhaps levelling through 2023 at approximately 7.5% on average. This is of course not guaranteed.

In addition, the bank base rate increases applied by the Bank of England from 0.1% in December 2021 to 1.25% in June 2022 in very quick succession have seen borrowing costs rise. The next Bank of England next decision is due in early August 2022. Remember that some mortgage holders have never seen the base rate rise above 0.75% (August 2018) in the last decade plus. The last time it was above this rate was February 2009, some 12 years ago, before which the rate had fallen over a six-month period by around 4% from 5%.

Sadly, the tragic war in Ukraine continues and the economic sanctions being applied by most nations to Russia I am sure will bite hard in the months to come.

With all these events occurring, it is possible to have missed the inverted yield curve occurring in US bond markets. I am sure you may have other things to think about, and you may wonder why this is important. Historically, this can be a pointer to a recession in the nearer future, possibly the end of 2023, and this is why the importance of this occurrence as a possible signal is to be noted.

Our colleague Steve Williams, Director at Cormorant Capital Strategies has provided some comment at the very beginning of April 2022 as follows:

There is a vigorous debate among both practitioners and academics about what all of this means. What, for instance, do the various interest rates apparent along the yield curve actually represent? Is an inverted yield curve a signal, or a cause of recessions? If it is a signal, how deep or sustained should the inversion register before we act on it? If it is a cause of recessions, what are the mechanics exactly?

As a consequence of all of this uncertainty, you can break those involved in the discussion into three groups, with the middle ground flanked on either side by those that automatically believe a recession will be preceded by an inversion and those that automatically reject any such notion. In terms of numbers, I'm guessing that the sceptics have the majority. And they include among them some professionals of high rank. Take Guneet Dhingra, head of US Interest Rates Strategy at Morgan Stanley, for example. He is quoted in the Wall Street Journal (22-Mar) as suggesting that a…

"…yield-curve inversion is coming. It's going to happen. But it's not going to be the usual doom and gloom that we often associate with yield curves inverting."

Some sceptics argue that a range of forces are pushing down on long-term interest rates, including various vaguely defined secular trends and extraordinary demand from pension funds and international investors, meaning that each time the Federal Reserve (the Fed) raises rates at the shorter end, the yield curve will necessarily 'flatten'. All of which is difficult to reject out of hand but, if I'm forced to take a side, I have to confess that my sympathies align more closely with Team Believe.

Steve continues on the topic of where this might fall when considering three outcomes, namely 1: Positive outcome, 2: Middle ground, 3: Negative outcome, noting:

I'm guessing that the middle ground is the more likely. That's because I expect the 3-month rate to track higher as the Fed increases the target for the Fed Funds rate on the one hand, and on the other I expect the 10-year rate to rise alongside increased Treasury issuance (to account for run-away Congressional spending) and forthcoming 'quantitative tightening'.

In that scenario, the porridge is just right since the middle ground isn't particularly destructive for either bonds or equities. Mind you, I can't pretend that I have a high degree of confidence in that outlook, so I'll be keeping an eye out for angry bears just in case.

Steve Williams, Director Cormorant Capital Strategies

The Chancellor reached the dispatch box on 23 March for the Spring Statement. The usual thoughts of 'being stuck between a rock and a hard place' sprang to mind, with little leeway apparently available. With real wage increases not keeping pace with inflation, many households and SMEs are struggling to make ends meet. The continued freezing of increases in the personal tax allowances as also not helped household income positions.

As a reminder, inflation is not normally a bad thing; indeed, stagnation and deflation are worse. High inflation can be difficult, but it has its advantages, especially if you have high debt levels (as noted below), simply because inflation has the effect of eroding debt. Some might think that a healthy bout of inflation might erode the debt that governments have amassed, as detailed further below. There is nothing new in this thinking - just look back to the UK economy of the 1970s and 1980s.

The last two years of the pandemic have seen mountains of debt being accumulated by governments across the globe. It's a bit quiet on that front, but whilst borrowing costs are so low, piling on debt for many nations has been cheap, and if it keeps the all-important cashflow going then most have considered it a price worth paying. However, this does not mean that the debt or its cost is under control, or that a planned pay-down process is in place. Some major economists have indicated their approval of additional national borrowing to get their respective economies going first, and then worry about it later. The 'worrying about it later' part may arrive a lot quicker than first expected with borrowing costs rising quickly. The most recent figures note that public sector net debt was equivalent to 94.7% of Gross Domestic Product (GDP) to end February 2022. More can be found here: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1062194/Public_sector_finances_February_2022_HMT.pdf

Chapters Financial is not responsible for the content of external websites

From a personal financial planning perspective, we have not really had to deal with high inflation rates for over a decade. If base rates continue to rise to control inflation, this might mean higher deposit returns, increased annuity and mortgage / loan rates and higher costs in the shops. Equities may gain as the spending filters through, but they might need to, to pay for higher price goods.

With these observations made, we remain optimistic for growth and returns over the balance of 2022, although there are some headwinds as economies find their feet and a way out of the lockdowns (past and present) that most have experienced over the last two years.

To our clients, and blog readers, we hope that you have an enjoyable Easter break in the middle of April 2022.

Keith Churchouse FPFS
Director
CFP Chartered FCSI
Chartered Financial Planner

Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899