The three things I would tell my clients this morning
The US appears to have reached a debt ceiling deal. If signed, it averts a global systemic credit event and growth takes a moderate hit.
We are way past the supply-side inflation part of the problem, and have moved into the wage-price spiral. Central banks found themselves behind the curve and are now racing to stop the spiral.
For a wage-price inflation to stop, central banks need to press hard on consumption.
The Bank of England is now projected to hike four more times.
The Fed may have paused, but looking at the statements of its officials, the next rate move is more likely to be a hike than a cut.
The EU is expected to hike twice.
Very slow growth + higher than average inflation = stagflation
The US debt ceiling drama seems to be moving behind us, as a moderate President and a less-than-expected-militant House Speaker reached an accord that will only have a moderate impact on growth. It remains to be passed by the individual caucuses in the Senate and the House, but the probability of a signed deal before the 5th June x-date seems very possible – at the time of writing (large caveat, this is politics).
Washington hasn’t seen real bipartisanship since before Dick Cheney’s Vice Presidency. Points for the deal should go squarely to a President who knows the system like probably no one else. More importantly, both party leaders have said that they would be happy to sign a deal even if that meant ignoring downvotes from their respective fringes.
It may be premature to assume, but a return to the political centre after more than a decade could be better news than the debt ceiling deal itself. In fact, a broad look at elected legislatures across the developed world, from the UK to France to Greece suggests that we may be close to a return to the more centrist policies that were prevalent before the 2008 Global Financial Crisis. The centre is where most things get done. Not all at once, but inch-by-inch (or centimetre-by-centimetre if you prefer). Big partisan laws, like Obamacare or the 2018 tax cuts, may move the needle quickly, but tend to generate so much backlash that their cost can be measured in generations.
To be fair, US growth didn’t have to suffer at all. When a country prints the global reserve currency it can borrow ad infinitum and saddle other countries with the bill. But even the almighty US Dollar can suffer from inflation. Last week core inflation rose to 4.7%, 2.5 times the central bank’s target. The negotiating parties knew that even if they didn’t slam the breaks on growth, the Fed would do it for them, so they were incentivised to reach a deal. Whatever the outcome, growth would have been the victim.
As the drama is nearly over (never say never until the ink is dry), we once again turn our attention to the real subjects of inflation and growth. Global growth is set to slow to the worst pace in decades. The US is expected to grow by a cumulative 3.84% in the three years between 2023 and 2025. Meanwhile, inflation is becoming more entrenched.
We are way past the supply-side inflation part of the problem, and have moved into the wage-price spiral.
This is the part where workers measure their importance and if the labour market is tight enough they decide they don’t want to pay higher prices, asking their employers to share the burden. Employers often must cave, especially in service economies with skill scarcities, and are then prompted to raise prices to compensate. Inflation goes up again next year, and the merry-go-round continues.
Very slow growth + higher than average inflation = stagflation.
Central banks found themselves behind the curve and are now racing to stop the spiral. The Fed may have paused, but looking at the statements of its officials, the next rate move is more likely to be a hike than a cut. The EU is expected to hike twice.
In the UK, which is reconstructing its economy post-Brexit, growth is slower and the skills shortages more acute. So is the wage-price spiral. Inflation grew by 1.2% for April, the third straight month that prices rose near 1%. Consumers are undeterred as demand remains fairly robust. The central bank has signalled that it might become more aggressive. As a result, the market is now pricing no less than four rate hikes until the end of the year.
Now comes the ugly part. For a wage-price inflation to stop, central banks need to lower demand to disincentivise companies from hiking prices and communicate to employees that they will not dole out wage rises. Lowering demand is a very nice and technical way of saying that people need to become poorer.
Hopes that the Fed will quickly reduce rates by the end of the year are fundamentally, for the time being, unfounded.
The exercise becomes more difficult as the famous skills-gap comes into the spotlight. For years companies have been complaining that they just can’t get the right staff. This is where the educational system has, in essence, failed us. Jorge Louis Borges, a famous Argentinian writer, suggested that in an infinite library of real and false knowledge, people might go mad or become dogmatic to cope. Where information and misinformation become abundant, filtering is a more important skill than learning. We live in an age where Artificial Intelligence takes initiatives and algo’s make choices we can’t decode. Yet students continue to sit in desks reminiscent of 19th-century factories, learning to receive (usually outdated) knowledge rather than filter and target it. The sad fact is that our age moved past our ability to take stock. Education, not the quickest evolving sector, is miles behind even that milestone. If one accounts for the poor western demographics, which have seen many boomers leave the workplace altogether and fewer Gen -Z’s taking their place, it becomes clear that the skills problem won’t be resolved anytime soon. For central banks, thus, to achieve their demand-reduction target, they will need to press hard on consumption.
Investors, businesses, and consumers should prepare themselves for at least a couple of years of slow growth, high inflation and constrictive credit conditions. For portfolio managers this means threats but also opportunities, as bad business models will be exposed and good business models (to which they are presumably exposed) rewarded.