Inflation anyone?

US corporate earnings hit a crescendo this week, yet most people are focused on the Federal Reserve and the fluid trade policies of the American President.

The Federal Reserve (Fed) has changed its spots with the new year; its resolute, steady increase in interest rates and reduction of the bonds and home loans it hoovered up in the aftermath of the global financial crisis has come to a sudden jarring halt. After an extremely delicate set of meeting minutes and public statements from the central bank, investors now expect a moratorium on rate hikes for the next 12 months. Quantitative tightening (the roll-off of debt securities mentioned above) may even finish in 2019, a few years ahead of schedule.

It’s not only shorter-term matters that are taking up the Fed’s attention. Last week Fed Vice-Chair Richard Clarida raised the possibility that the central bank will amend how it manages inflation. Rather than aim to keep prices anchored to roughly 2% growth each year, he noted that the bank could move to a “cycle” approach where the Fed would “make up” for lower inflation in the past by letting inflation rise above 2% for periods of time. Independent central banks tend to undershoot their targets while steering well clear of the dangerous feedback loop that is deflation (falling prices or a negative inflation rate) because their mandates were written in response to runaway inflation of the 1970s and 1980s. Nowadays, central banks seem much more concerned about deflationary funks like the one Japan has grappled with for decades. Mooting a policy where inflation will be stoked up to compensate for any periods of muted price growth seems to fit with this theme.

There’s a wonderful contradiction in finance that comes from some investors arguing that politics and policies in general have no impact on investments even while the organs of these policies are watched feverishly. Businesspeople are very aware of how the whims of government affect their day-to-day operations. Whether it’s a small change to labelling regulations that mean a complete redesign of packaging, a ban on the use of a type of plastic that triggers a hunt for a new supplier, or an emissions-trading scheme that creates a new cost that must now be weighed when evaluating a project. Policies matter.

And some of the most profound changes to the business environment come from small changes at the very top. By raising the amount of inflation it allows in the system, the central bank is increasing the amount of money flying around. Like everything else in the world, by making something more plentiful you cheapen it. The result of such a policy would be to encourage borrowing, because money is worth more today than it will be in the future. Why not get more cash in your hand today if you know you will effectively be paying back the loan with lower-valued money? If the central bank does move to such a policy, what effect would it have on companies, given record low interest rates have already pushed them to take on more debt than they had during the financial crisis? Collectively, the companies in the S&P 500 Index have about twice as much debt as the annual earnings they can use to service it (known as Ebitda). That level hasn’t been seen since the dot-com bubble of 2000 …

Expect Fed Chair Jay Powell to get a good, long grilling by Congress when he testifies on Tuesday and Wednesday. Another person who’s preparing for a tough week in the legislature is UK Prime Minister Theresa May. There’s a high likelihood that Parliament will vote to extend the Article 50 deadline, something that Mrs May has refused point blank to do. Our embattled leader has promised a meaningful vote on her Brexit deal (whatever it is by the time she has finished hustling) on 12 March, but that’s unlikely to placate MPs on both sides of the aisle who feel she’s trying to run down the clock and force her deal through by threatening a no-deal. Mrs May’s political capital is, unfortunately, in overdraft.

Source: FE Analytics, data sterling total return to 22 February

Two ways: gradually, then suddenly

US President Donald Trump has delayed the imposition of tariffs on $200bn of Chinese imports that were set to come into force on 1 March. He tweeted (of course) that “substantial progress” had been made in the negotiations. Among other bugbears, Mr Trump specifically mentioned intellectual property and the currency. Americans have long grumbled that China cheapens its currency to make its exports more attractive, while its businesses routinely steal overseas’ companies’ technology and branding. Talking heads now believe a deal will be signed in March or April, bringing the nations’ trade tensions to an end.

If this is the case, one of the major concerns bedevilling global markets will disappear – at least for the next year or two. And if the US can force better intellectual property protections for foreigners behind the Great Wall all the better. In fairness, China has already beefed up such measures in recent years. As you would expect as its companies become innovators themselves – they want their government to help them protect their ideas. According to the World Intellectual Property Organisation, 44% of global patent filings in 2017 were lodged by Chinese firms – twice as many as American firms. And when foreigners go to bat in China for trademark misdeeds they tend to win more often than not and are awarded more in damages than locals receive. Fines remain very low relative to global norms, but they are rising.

We think Mr Trump will renege at some point, heading back to grind out more concessions at an opportune moment. Unfortunately, this is short-term thinking. Every time the President devalues his word – or the Fed devalues its currency – the soft power of the US is diminished. Why would other nations or foreign investors use the dollar as a store of value and to settle cross-border transactions if they can’t trust its institutions to maintain a level playing field? That’s an easy one – because everyone else uses the dollar. But this network effect tends to hold right up to when it doesn’t: that’s why a good portion of the world checks Facebook 15 times a day rather than MySpace.

As a British drunk noted in Hemingway’s The Sun Also Rises, there are two ways you go bankrupt: gradually, then suddenly.

Bonds

UK 10-Year yield @ 1.16%

US 10-Year yield @ 2.65%

Germany 10-Year yield @ 0.09%

Italy 10-Year yield @ 2.84%

Spain 10-Year yield @ 1.17%

 

Economic data and companies reporting for week commencing 25 February

Monday 25 February

US: Chicago National Activity Index, Wholesale Inventories, Trade Sales, Dallas Fed Manufacturing              

Final results: Bunzl, Hammerson, Hiscox, RTC Group

Interim results: Dechra Pharmaceuticals, Finsbury Food Group

Trading update: Associated British Foods
 

Tuesday 26 February

UK: BBA Loans for House Purchase, BoE Governor Mark Carney Speaks to Parliament

US: Housing Starts, Building Permits, House Price Index, Richmond Fed Manufacturing Index, Fed Chair Jay Powell Speaks to Senate, Consumer Confidence Index, Conference Board Present Situation

EU: GER: GfK Consumer Confidence               

Final results: Augean, Croda International, Derwent London, Drax Group, Lighthouse Group, Persimmon, Standard Chartered, Travis Perkins, Verona Pharma

Interim results: Green REIT, Hotel Chocolat

Trading update: Babcock International Group
 

Wednesday 27 February

UK: BRC Shop Price Index

US: MBA Mortgage Applications, Advance Goods Trade Balance, Retail Inventories, Wholesale Inventories, Fed’s Powell Speaks to House of Representatives, Pending Home Sales, Factory Orders, Durable Goods Orders

EU: Money Supply (M3), Economic Confidence, Business Climate Indicator, Industrial Confidence, Services Confidence, Consumer Confidence

Final results: Capital & Counties Properties, International Personal Finance, ITV, Law Debenture Corp, Metro Bank, Nichols, Provident Financial, Rio Tinto, Riverstone Energy, St James's Place, Tarsus Group, Taylor Wimpey, Unite Group, Weir Group

Interim results: Clinigen, Pantheon International
 

Thursday 28 February

UK: Nationwide House Price Index, GfK Consumer Confidence, Lloyds Business Barometer

US: GDP (Q4), Personal Consumption, Core PCE, Chicago Purchasing Manager, Kansas City Fed Manufacturing Activity

EU: FRA: GDP (Q4); GER: CPI, Import Index             

Final results: Amigo Holdings, Aston Martin Lagonda Global Holdings, Arrow Global Group, British American Tobacco, Bovis Homes Group, CRH, Foxtons Group, Hunting, Howden Joinery Group, International Consolidated Airlines Group, Jardine Matheson Holdings, Merlin Entertainments, Mondi, Petrofac, Rolls-Royce Holdings, RSA Insurance Group, Rentokil Initial, Spire Healthcare Group

Interim results: Genus
 

Friday 1 March

UK: Net Consumer Credit, Net Lending Secured on Dwellings, Mortgage Approvals, Money Supply (M4), PMI Manufacturing

US: Wards Total Vehicle Sales, Personal Income, Personal Spending, ISM Manufacturing, ISM Employment, University of Michigan Expectations

EU: Manufacturing PMI, Unemployment Rate, CPI; GER: Retail Sales, Unemployment Rate, Manufacturing PMI; ITA: GDP (2018)

Final results: Jupiter Fund Management, London Stock Exchange Group, Robert Walters, William Hill, WPP

Total votes: 33