Better times ahead

The first cut is the sweetest?

Neither the US Federal Reserve, nor the Bank of England (BoE) nor the European Central Bank actually did anything this week. However, there was plenty in the smoke signals, even without action on policy rates.

For the BoE, the constellation of Monetary Policy Committee votes shifted decisively. No longer are two of the members voting for further policy rate rises. Both ‘hawks’ rejoined the pack, taking reassurance from data showing inflationary pressures continuing to dissipate. One member still argued for lower interest rates, a process which should now begin in the early summer (baring any major curveballs). (Figure 1)

We still expect this inflationary hump to continue moving on out of the system in the months ahead. So far, evidence for the dreaded second-round effects, key to determining how long this unwelcome visitor tends to stay, is substantially absent.?

The set of challenges facing US central bankers are, as usual, plenty different. Inflation is already closer to the target than elsewhere. Meanwhile, the economy would appear to be straining at the leash a little more than the UK. Some still wonder whether policy rate cuts will be appropriate at any point this year. Our hunch remains that they will, and the summer is still a likely starting point. For now at least, the UK base rate remains at a 16-year high, while the US base rate is at a 23-year high. (Figure 2)

This week's Word on the Street Podcast covering the central bank action...

Melt up probability rising?

In the background there are also some tentative signs that some of the US economic heat was spreading to other parts of the world. The reminder here is that the US consumer is a powerful force well beyond the confines of the US economy. Most Americans who want work have it. There too the combination of low unemployment, falling inflation and powerful increases in household wealth, are combining to give consumers plenty of fire power.

Meanwhile there are some scattered signs of life in manufacturing and some of the early cycle areas of the global economy such as Chemicals.

There is a broadening strand of the future where you can imagine inflationary pressures continuing to subside, allowing central banks to begin cutting interest rates mid-year. Add to this growing excitement surrounding the incoming changes in the technological frontier, and some revival in some long-sedated parts of the global economy, and you can see some cause for excitement.

Of course, it is our job to imagine both what could go right and wrong on the path ahead. Only then can we find the appropriately sober mix of assets to best deploy on behalf of our clients. Even so, a pick-up in global growth, amidst improving prospects for productivity, would be very helpful for investment returns.

But titan risk…

One of the many interesting artifacts of the modern economy is proliferation of winner-take-all markets. In many previous macroeconomic paradigms, the ability of a single firm to dominate entire markets was often more constrained by a variety of factors. However, in multiple industries we see scale and network effects compounding the influence of a clutch of mega firms.

Internet search is an oft used example. The more people use a particular search function, the more surgical the underlying algorithms can become, which in turn attracts more punters and so on. The same is true of other areas such as social media where of course you want to be on the same platform as your friends and family, which in turn multiplies monetisation opportunities for the platform.

In other sectors the scale advantage can be seen in the ability to deploy expensive enterprise software and other fixed cost outlays that would swamp the smaller, regional competition.[1]

This is part of the reason why we are finding an unusual, but far from unprecedented, degree of single stock concentration in several of the world’s stock markets. In the US, the 10 largest companies now account for over 30% of the value of the index, the highest level since the 1980s.

The concentration of the index around a handful of companies focuses certain risks. Anti-trust is one that we highlighted at the beginning of the year, and it returned to the headlines again this week. The relevant authorities certainly appear to be broadening how they view anti-competitive behaviour after a long period of focusing primarily on the effects on price.

In summary

There is much on the horizon for investors to get excited about. And as always, there are some uncertainties and risks that need to be carefully monitored.

For now, markets are pricing in the first round of central bank interest rate cuts in major economies, this summer. The long wait is nearly over.

[1] https://www.productivity.ac.uk/news/a-new-season-of-the-productivity-puzzles-podcast/

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