Blain’s Morning Porridge 20th June 2023: The Best of Times and Worst of Times; The US, UK and Climate Threats
“It was the spring of hope, it was the winter of despair.”
The widening gulf in the outlook for the US and UK economies is stark. UK housing and the mortgage markets are a rising threat – but maybe we are looking at the all the wrong things as the Climate Crisis (oh, yes, remember that) comes back into focus.
(Sorry for lack of Porridge Monday morning– but I was on the early Radio and then a call to jump on..…)
This morning I shall demonstrate – once more – my tragically-narrow Anglo-Saxon world view, but bear with.. I promise to get onto Japan, China and Europe later this week. Markets are focused on a tale of two cities: Washington and London. It really is looking like the Best of Times versus the Worst of Times as the outlook for each diverges.
As the Federal Reserve sits back to monitor the effects of “Skipping” the June rate hike last week, there is a small chance they might just emerge looking like geniuses as US inflation naturally slows and the numbers downtrend. In contrast the Bank of England will be hiking again this Thursday. They have been banished into the corner, wearing the dunces hat following multiple failures in the art of predictive inflation guessing. A central bank with a credibility issue is not a positive look for a nation trying to persuade the global economy it is on track. It’s all about confidence – and the UK is short of it.
A consensus is developing the US is unlikely to plunge into deep recession, sustained by a vibrant economy, deflationary signals (like housing costs dropping), stable energy prices and lower price impulses across the economy. Markets expect 2 more cautious Fed Hikes. Despite a labour shortage there is little sign of a wage demands overwhelming the economy. Even when the Fed flooded the banking sector with liquidity earlier his year as banks wobbled, analysts reckon deflation will see US price hikes slow below 2% as early as this year – I reckon longer, and inflation will stick higher, but at bearable, sustainable levels.
I still reckon the US stock market is massively overvalued – after the QE and ultra-low rate distortions of the 2010s, when the market was fuelled by zero-price money and its relative attractiveness to bonds. I simply don’t think the S&P 500 justifies a 22.23 times PE ratio – at today’s normalised interest rates, but I suppose that is the point: stock markets believe US rates are going back to 2%. Maybe..
Contrast with the UK. Across Blighty company boards, business owners and consumers are preparing for worse to come – they are cutting spending and investment plans, cutting expenses, and cutting jobs. UK mortgage rates hit 6% again y’day confirming massive pain ahead for a substantial part of the population already battered by 20% food inflation, de-facto rising taxes, and unconstrained energy inflation.
Although sterling is strong and gilts yields higher – with no sign of panic (yet) – stagflation (or, at best, inflationary flat-lining) looks nailed on. The fact the housing market has gone beyond the ken of man, and real wages are lower than during the last millennium is bad enough. Underlying a developing sense of economic crisis is a growing rational assessment of Brexit – just how badly has the UK cut itself off from not just Europe, but the global economy. Uncertainty drives desperation: a 7% plus wage inflation tsunami, price gouging, political dither.. etc, etc, I won’t bore you any more with how bad it feels. The very best outcome looks like a massive consumer spending crash – with all that entails for the high-street.
The UK is particularly sensitive to its housing market – it’s a key measure of national confidence. It has become massively distorted and inflated by failed policy decisions these past 12 year which have accelerated home prices to 12 times average incomes (unsustainable) while ensuring home building has been less than 1/3rd the level required. It’s been a massive benefit to rentiers and owners. Now the “owners” are finding their pips being squeezed as the combined effects of leverage, interest rate sensitivity, and declining incomes make owning a home, or renting it, an overwhelming financial burden.
The UK’s confidence is cracking. People are close to panic about the housing market – and how personally vulnerable they are.
A recent report reckons over 1.7mm UK mortgage holders are in “extreme danger”- 22% of UK households. They are stretched to the max, paying off the minimum on credit cards, with zero-savings, while facing higher mortgage costs in the next 12 months. They just don’t have the money available. A further 1.3mm UK households are “at risk” – despite good jobs and above average incomes, they are in a fragile economic position. It’s no wonder the housing market is seen to be a proxy for the financial confidence of the nation.
One of my colleagues hit me back when I raised this on Friday – “Bill, don’t worry.. you are the one always telling us things are never as bad as fear, so why so negative on UK? The govt can still reopen QE and cut rates if it gets too bad, or they can subsidise mortgages..” At which point I nearly lost the will to live… that would be genuinely bad.. but financial markets would love it. Distortion pushing up prices. Bosses will get richer, markets will soar, nothing will get fixed and the poor will get poorer.. and it will be inflationary.
The risks of “the economics of bread and circuses” will rise as we approach the coming UK election (non-UK readers: sometime in the next 18 months..)
Markets think it’s all about inflation, growth and stock prices. The UK has the extra spice of a mortgage crash – which, yes, will probably trigger another crisis in banking. But if we beat inflation and rates fall, then stocks and bonds will be off to the races.
But…… What if inflation isn’t the big issue?
I got woken at 4 am this morning by perhaps the loudest crash of thunder ever, and then rain threatening to hammer through the ceiling. More than a few readers won’t like me commenting on the Macro implications of Climate Crisis – but, it’s out there. Couple of headlines in recent weeks have set me thinking.
- A new El Nino event in the Eastern Pacific, plus a 4 degree plus heat plume in the North Atlantic, and around the UK (which is driving the current storms)…..
- Global Temperatures set to climb far higher than the 1.5 degree Paris Agreement….
and most critically,
- Two weeks ago, California’s largest insurer, State Farm, announced it is no longer writing insurance in the state due to rising wildfire risks.
The reality in California is it’s not actually wildfires that are the problem. Its state legislation designed to keep insurance costs low that stops insurance companies raising rates to cover increased wildfire risk that’s broken the state insurance market. Insurers can no longer afford to cover rising risks at prices effectively capped by policy – therefore they pull out. Classic regulatory foot in mouth moment just as dry, highly-combustible conditions, a shortage of water, and changing weather patterns across the South West USA have significantly raised climate-related risks.
Hook that up to rising temperatures and figure out the economic uninsured losses that may result. Some time back I read a climate-porn article that claimed: for every 10th of a degree the oceans heat up, the risks of storms, tidal storm surges and flooding increases 10 times… Yay. That’s not actually correct. We have no idea what happens when ocean temperatures rise, and its certainly not linear – rising sea temps will be quadratic and Chaotic in their consequences. And probably much, much worse.
Chaos isn’t just the state of your kid’s bedroom. Chaos happens when predictable relationships and events suddenly break out from the cone of expectations, heading off in random directions, triggering multiple unintended consequences. That’s the big risk with climate change – we really don’t know what happens next.
We can make educated scientific guesses… (or simply be the Frog in the Pan and deny the water is getting warmer..) It’s generally accepted Global Temperatures have risen 1.2% since the pre-industrial age. Scientists think we could hit 1.5 degrees as early as 2027. In 2015 Climate scientists persuaded politicians to embrace the 1.5 degree target for capping global temperature rises in Paris – thinking that would be a manageable level before climate turns chaotic.
Unsurprisingly, we are going to miss 1.5 degrees by a massive margin. (In case you are wondering we won’t actually know till maybe 2047, as global temperature is measured over a 20 year time frame…)
Rising temperatures will not hit the global economy equally. Some countries may initially experience some flooding and drought, more wildfires, more storms and more rain – suffering losses and pain from uninsurable losses. Other regions could become swiftly unbearable – typically the poorest, most volatile regions triggering all kinds of economic, geopolitical and conflict consequences. Around the polar regions, where temperatures are rising fastest we simply don’t know what happens if ice-sheets melt (7 meters higher sea-levels means my house is gone..) or if it triggers earthquakes and vulcanism as land masses rise. The Alps are crumbling as the ice that binds the mountains together melts. (But, you already knew all of that… I just repeated it because sometimes you have to keep stating the downright bleeding obvious..)
According to New Scientist: 2023 is shaping up to be the hottest year on record. We just had the second warmest May on record, and June looks likely to break global records. The real issues, and related to the new El Nino and the Temperature plume around the UK – is that on June 11, the average temperature in the North Atlantic was 22.7 degrees – half a degree warmer than any other June number in recorded history! At 26 degrees warm water drives the formation of Hurricanes. Equally damaging is much of that warm water is swirling round Greenland where it will speed up ice-melt, threaten the North Atlantic drift, and everything else we’re pretty much convinced ourselves won’t happen about rising sea levels.
What’s changed? Scientists aren’t sure, but the obvious weather feature here in the UK this year has been the weaker and less predictable jet stream, resulting in two weeks of Easterly winds across the UK (unusual), record flooding across Europe, and a lack of dust being blown northwards which contributes to global warming because desert dust reflects sunlight back into space. Weaker winds could suggest the planet’s dynamic systems of winds and ocean currents are in flux or crisis. If they break down.. we are in trouble.
I don’t want to scare anyone…. but while I spend all day in the office watching inflation shocks, trying to figure how bad a mortgage shock may be on the UK, and try to figure out the direction of stocks, bonds and relative value trades, it’s possible what’s going on outside the window is the really critical issue we should be paying attention to.. What happens to the global economy if climate related weather events turn nasty this summer, and they are increasingly un-insurable? I have an awful feeling we might just be in for a shocker – I hope that I am wrong..
“I pay to read the Morning Porridge about markets, not about climate speculation… “ says the angry red looking Frog in the pan of water on the hob..
Five Things to Read This Morning:
New Scientist Why 2023 is shaping up to be the hottest year on record
Out of time, back to the day job, and tomorrow will be about the Paris Airshow and Planes!
Strategist – Shard Capital