Week ending 21st April 2023.

Today’s (Friday 21 April 2023) PMI readings from the US, UK and Eurozone for April all came in higher than March’s readings and ahead of economists’ forecasts: at 53.5, 53.9 and 54.4 respectively. 50 is the line separating expansion and contraction, which suggests that not only are these economies recovering, but more importantly, their recovery is accelerating.

Unfortunately, this is likely to give central bank policymakers the confidence to continue with their aggressive interest rate increases.

However, one saving grace came from Silvana Tenreyro, a BoE policymaker – and we wonder if Silvana Tenreyro is a reader of our Weekly Market Updates, as she compared her BoE colleagues to being a “fool in the shower”, as we have used Milton Friedman’s “fool in the shower” analogy many times over the past few months (for an example, please see here and here).

This is where a person gets burnt by hot water after they turn the hot water all the way up given the shower water initially comes through cold – and we believe that central bank policymakers in the US, UK and Eurozone are all guilty of being too aggressive in increasing interest rates in such a short period of time, they clearly haven’t taken into account the impact of their previous increases (as these can take time to fully filter through, just like hot water in a shower).

Whilst on the surface, inflation readings (for example, this week’s UK CPI reading which came in at 10.1%) would suggest that interest rates aren’t restraining inflation and therefore need to be increased further. However, we don’t think inflation is the problem policymakers keep saying it is.  We have long argued that the current inflation has not been caused by a sharp rise in demand and that inflation will fall sharply this year simply due to what is known as base effects.  In fact, in the UK inflation could potentially be close to, if not below, the BoE’s 2% target by the end the year.

Moreover, energy price rises have already made us all poorer.  This, coupled with the fact that tens-of-thousands of two-year fixed rate mortgages are due to expire over the course of the year (simply because people rushed to move house two years ago in order to take advantage of the stamp duty holiday), will mean many of us will see our disposable income shrink further as current mortgage rates are significantly higher than they were 2 years ago.

Given the consumer accounts for around 60% of the UK economy, a decline in spending would quickly tip the UK into a recession – hence the need for policymakers to take a breather and wait for the impact of the interest rate increases over the past 12 months to come through.

And this isn’t just a UK problem – US car loan arrears are rising, more Americans are relying on their credit cards to fund day-to-day spending (and consumers account for two-thirds of the US economy) and comments in the Fed’s Beige Book report which was released on Wednesday (19 April 2023), suggest there is a risk that the US recovery could stall as the recent banking crisis may make it more challenging for households and businesses to access loans.

Looking ahead to this coming week we have US durable goods orders; US & Eurozone Q1 GDP; US PCE (the Fed’s preferred inflation measure); and Japanese retail sales.

Investment Management Team