Higher for Longer – Markets Could Struggle With the New Reality

Blain’s Morning Porridge – 22nd September 2024: Higher for Longer – Markets Could Struggle With the New Reality

“I’m a catalyst for change. You can’t be an outsider and successful for over 30 years without leaving a certain amount of scar tissue around the place.”.

The Bank and The Fed have served notice they will remain vigilant – higher for longer! Markets would be wrong to expect early easing. Wage Inflation and Energy remain very real threats over the medium term – it may trigger volatility as markets understand the new reality.

In late 1979 the UK base rate peaked at 17% as wage demands and oil prices threatened to turn stagflation into economic meltdown. Yesterday, Bank of England Governor Andrew Bailey cast the deciding vote to hold UK rates at 5.25%, halting a series of 14 successive hikes – warning The Bank remains ready to hike further. His comments echoed Fed Chair Jay Powel’s from earlier this week – the Fed is also on hold, but vigilant.

I fear the market has not been listening closely enough to what Powel and Bailey have said.  What they hear is not: “We Wait”. Markets still believe rates are going to fall – setting up for another leg up in stocks, and even bonds yields to start falling. How quickly the realisation of “higher for longer” takes to set in will determine market volatility in coming months.

Steady, boys. Steady.  This could get messy.

I made a bet early this year US and UK rates won’t start to ease until Q2 2024 at the very earliest. I now think I’ve maybe called that shift early. We are set for high/rising rates for longer – and that means bond yields will remain elevated, setting higher barriers on the relative value of stocks as a credit crunch deepens.  It means more credit pain still to come across industry and consumers.

Open any economic history book and they show rising rate phases are seldom linear. They jerk upwards in a series of “plateaus” of differing length as central banks assess the damage they’re doing to the economy as they to balance inflation vs recession risks. The effects of any hike have lagging effects on consumption, demand and production – and predicting these remains more art than science.

For instance; talking heads in the housing sector say the prospect of falling mortgage rates will cause housing demand to rise – but that assumes everyone is fine and able to afford their higher credit card bills, bigger utility bills, and got a massive pay-rise that enables them to fund the weekly food shop. For most folk, it hasn’t. The realisation of much more badly off we are is only now sinking-in across the economy.

(One of my chums is the local estate agent: he can tell when crisis is coming: when he doesn’t have to work hard. When he has a slew of homes to sell and a plethora of buyers, it means the job does itself. Today.. he’s working himself ragged. He sees there is less and less money out there – real prices are down far more than the headlines tell us. Smart folk don’t mind selling their current home cheap when they can buy the next one cheaper! Or so he is trying to persuade us!)

As the US, Japan, Swiss and UK hold, Europe is slightly behind the curve; the ECB, plus Sweden and Norway are still hiking. The reality is Bailey, Powel and ECB head Christine Lagarde can say what they will, but its “events, dear boy, events” (as UK Premier Harold McMillan described what frightened him most), and what happens next that determines where we go from here.

Guess what:

• Its wage inflation and energy prices that are still the likely determinants of where prices and thus rates go next.
• It will be consumption that determines whether economies tumble into recession.
• It will be market confidence (bonds, stocks and, yes, housing) that set the confidence and sentiment of market participants (basically all of us) to withstand these shocks.
• It will be “events, events” that set what happens next.
• These factors are dynamic and influence each other.

Wage inflation is not done yet.  Workers are not going to scale back their demands because rates are on hold – they want to get ahead of the curve, and ahead of the pack.

Here in the UK we are headed into the next phase of increasingly bitter strikes, leaving us set for a winter of at least “annoyed frustration”. The case of professional medicine versus a la-la-la-I’m-not-listening government highlights is merely one aspect of the problem. Doctors are becoming politicised because, just like everyone else, they can read headlines of 8.5% wage inflation further eating into the long-term paring-back of their real salaries. Wages are a relative thing – everyone wants to be relatively better paid, but the Government are setting the narrative of evil doctors putting patients at risk – when its them that have refused to negotiate.

Ask yourself: do you want talented, motivated and skilled doctors, or an MP with his eye on the greasy-pole looking after you?

In the US the strike to watch is the United Auto Workers – UAW. Ahead of a bitter US electoral cycle, expect “labor” demands and unrest to mount.

The second aspect of wages is the high cost of labour – companies are still having to pay up to hire. Economies are still discombobulated by the complexities of the post-pandemic reopening. Demand for labour remains high but constrained by workers exiting the workforce. As I’ve found looking closely at the aviation industry, there simply aren’t the trained engineers available after retirals, layoffs and the failure of the major manufacturers to focus on training and professional development over the last few decades.

(That’s a subject for a proper rant one day: how professionals like engineers, scientists and doctors became line items on cost-accountant spread sheets rather than business life-blood over the past two decades.)

Energy prices shocks are not done yet. Oil prices are up 30% since early summer. $100 will hurt at the pump, and the first signs Winter is Coming have just arrived. The IEA is warning OPEC+ is creating a “significant supply shortfall”. What happens in China could be critical – if the current decline was to be arrested, then rising China demand could reverse many of the expectations of China exporting deflation.

And finally:

I wish I had time this morning to comment on Rupert Murdoch. Retiring? Boll-chocks I reckon. Chairman Emeritus with his hands still on the strings. The story is not his success, empire-creation, mistakes, decline and fall, or the succession battles – it’s about how Murdoch has been able to influence the narrative. Through history there have been a very small number of individuals in positions of power, wealth, as part of the intellligencia or through culture have wielded influence out of all proportion to their apparent stature.

What was Murdoch’s secret sauce? And what are the lessons for today’s populist political threat? I’ll be thinking about these over the weekend.

Next week I’m travelling, and it’s unlikely I’ll be able to get the porridge out on a regular basis. If my schedule works out I may even get to Oporto in Portugal – a place I’ve always wanted to see – next weekend. Port and Douro – what could be better?

If anything urgent comes up, send me an email and I’ll respond.

Five Things to Read This Morning

New Statesman             Liz Truss’s return is a gift to Labour

FT                                 Rupert Murdoch resolves his own succession drama – for now

BBerg                           Marcus Ashworth: BOE Waves the White Flag in Inflation Battle

WSJ                              Rising Bond Yields, Interest-Rate Worries Drag Stocks Lower

Project Syndicate          What Climate Finance Needs

Have a great weekend, but I’m out of time and off to do the day-job..

Bill Blain

Strategist – Shard Capital