Morning Briefing 14/7/21

Wednesday, 14th July 2021 09:22 - by Mark Palmer and Ben Timms

Prices have increased more in June than in any other time since 2008, as inflation continues to run rampant in the US. The year on year increase for June came in at 5.4%, higher than the already lofty 5% estimate of most economists and high enough to warrant comment from the White House that they “expect that these things will work themselves out in the not too distant future, but I can’t say exactly when”.

The biggest price growth areas are those that this time last year were doing nothing but have now taken off, such as air fares, used car sales and transportation costs – so that’s an understandable uptick from very low, lows.

Markets have started to take confidence in the officials who continue to call inflation transitory and largely ignored the number yesterday.

Former US Treasury secretary has cautioned that though investors are discounting the possibility of inflation sticking around, markets aren’t the best predictors of this and “at times when inflation has significantly accelerated in the past, such as in the 1960’s, markets have lagged rather than anticipated developments”.

There’s another side to the argument though, and that comes from Cathie Wood, the CEO of Ark Invest. Her view is that deflation will be the biggest market driver over the next five years and that with technological innovation spurring big advances, costs are going to start falling in key areas such as medical care, transport and artificial intelligence (and AI will then in turn push costs down further). This ‘good deflation’ is going to put pressure on businesses that haven’t innovated or adapted which in turn will spur ‘bad deflation’ where companies that haven’t innovated or invested start to suffer at the hands of those that have.

Ms Woods also sees inventories building back up to well above where they need to be by the middle of next year, which will alleviate commodity demand and should see their prices start to unwind. This article was written back in May, but she reiterated her views to Reuters yesterday.

US Democrats have put together another spending package which would cost roughly $3.5trillion! The package would expand Medicare, boost federal safety net programmes and tackle climate change.

This would be fully funded through tax rises and there hope is that they can use a process known as ‘reconciliation’ to get the agreement though, rather than it go to a vote in the senate, which they would inevitably lose as it would require a majority of 60, not just 51.

Even if the plan were to be fully funded, there would be a lag between implementation and tax receipts which would put further pressure on an already ballooning budget deficit, which is on course to hit $3trillion in this fiscal year (October1st – September 30th).

This would be the second successive year of a $3trillion+ black hole and is even starting to cause some Democrats to think in terms of austerity rather than spending their way out of the problem. The Washington Post has a piece on the proposed legislation, whilst Bloomberg covers the budget deficit.

The FT has an interesting piece this morning on the demand for exposure to Chinese assets from overseas investors. They say that despite the current tensions with Beijing and Washington, investors have now amassed an exposure of $800bn in stocks and bonds and the rate of purchase is at its highest ever.

China offers an interesting diversification away from tech stocks and into industrial assets with high growth potential (not only is China growing, but they supply the rest of the world) which work as a nice hedge to technology that may have over extended its run higher during the pandemic.

Chinese government debt also yields 1.5% more than its US equivalent which, given inflation is where it is, means less real-term value erosion. As China continues to open up its capital markets the pace of inflows is only likely to increase and though the numbers are still relatively small, they will start to grow and could one day become a challenge for the US in terms of where investors choose to park their money.

In the UK: Boris Johnson won the vote on keeping the reduction in the UK’s overseas aid budget last night. The vote was expected to be lost by the government after the initial backlash was palpable on both benches, but Rishi Sunak published a formula on Monday that said the government would reverse the cut once the UK wasn’t borrowing to fund day to day spending and once underlying debt as a share of GDP was falling (due around 2025-26 according to the OBR) – this gave would-be rebel Conservatives an easy out to stay in line with their party. Theresa May blasted the government for the move though and Sir John Major said “the government has blatantly broken its word and should be ashamed of its decision”.

UK inflation numbers have posted higher than expected this morning, coming in at 2.5%. Once again it was the sectors that are back up and running causing the biggest changes, with transport and restaurants and hotels being responsible for the biggest gains. We’re now just 0.5% away from the Bank of England’s forecast peak but getting there more quickly than many had expected and as such Sterling is having a reasonable morning off the back of it. The data remaining for today includes European industrial production, US producer prices, and oil inventories.

Have a great day.

This article was taken from Hamilton Court FX.

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