As recession looms, central banks have no good options
As the world’s biggest investment banks prepare to report third-quarter earnings in October, the signals are bad across the board.
As the financial world gathers in Washington DC for the annual meetings of the IMF and the IIF, it faces one of the grimmest outlooks on record.
At the time of writing the US Federal Reserve was expected to announce a 75-basis point increase in interest rates on September 21, with the Bank of England seen hiking by 50bp one day later. Some in the market have been pricing in even higher increases for both.
It was a fearsome September. The Bank of Canada hiked by 75bp early in the month, making it the most hawkish central bank so far. It has now raised rates by a full three percentage points since March, to stand at 3.25%.
And on September 20, Sweden’s Riksbank shocked with a 100bp move that was its most aggressive in 30 years. With fewer meetings than many peers, it is expected to raise rates again in November.
The World Bank, which thinks global core inflation will be 5% in 2023, cutting growth to 0.5%, warned recently of the risks of a global recession if all central banks raise too fast too quickly. It has argued for co-ordination – but not the kind that seems to be playing out as central banks compete to earn their hawkish chops.
The wrong way
Historians will debate the extent to which policymakers reacted too late on inflation as the world emerged from the coronavirus pandemic. Right now, the debate is over terminal rates: 'higher for longer' is the assumption. Many analysts consider recession to be inevitable, at least in Europe – perhaps not deep, but prolonged, nonetheless.
The data still looks to be moving the wrong way for the World Bank to get its wish for restraint. The Bank for International Settlements has warned of the dangers of wage growth driving inflation, most obviously in inflation-linked pay, something that is an understandable objective for workers’ unions. The European Central Bank has even faced calls from its own staff for compensation to be linked to rising prices.
A post-Brexit race to the bottom will hardly help London’s cause. In investors’ eyes right now, the UK is unsettled enough
A US consumer price index print of 8.3% on September 13 dashed any hopes of an imminent dovish pivot from the Fed. Chair Jerome Powell had already committed to “keep at it” at Jackson Hole in August. Markets have sold off hard in response: the S&P500 saw its worst performance for two years on the day of the print; the 2s/30s Treasuries curve was seen at its most inverted since 2000.
The near-term outlook for companies’ ability to raise financing or capital for growth looks awful. As the world’s biggest investment banks prepare to report third-quarter earnings in October, the signals are bad across the board. The head of JPMorgan’s investment bank, Daniel Pinto, has warned that fees could be down by 50%. That private markets appear to be finding ways to resist valuation contagion from public markets is scant consolation to many.
One bright spot might be in credit, where default rates remain under control so far. Some analysts are hopeful that credit markets are entering a period of likely recession with sufficient shock absorbers to avoid a crash. The loan market – floating-rate, and with more flexible underwriting standards than bonds – will be keenly watched for signs of distress.
Against a worrisome global backdrop, the UK’s economy looks shakier than some. The BoE’s interest rate decision had been postponed by one week following the death of Queen Elizabeth II, and Britons who spent the previous two weeks preoccupied with the ceremonies of state are now turning their thoughts back to their troubled economy.
Inflation-targeted policies like those designed to help households weather the energy-price storm are widely considered certain to contribute to inflation when the government borrows from markets to pay for them.
Fears of an emerging market-style currency crisis look misplaced, given that today’s concerns are driven neither by foreign-denominated debt nor by fixed exchange rates. But currency traders have nonetheless already taken the pound to lows not seen since the 1980s, beyond levels explained merely by dollar strength.
New prime minister Liz Truss has promised a Big Bang 2.0 for the City of London. In doing so, she adds her own voice to a recent tradition of boosterism that has relatively little to show for it. Inevitably, fresh attempts are to be made to convince SoftBank to plump for at least a dual listing of its Arm microchip business, as if sharing one outsized deal with New York will transform how London’s main market values tech stories.
She may have more success with plans to scrap a cap on bankers’ bonuses, a move that is an easy target for populist critics during a cost-of-living crisis, but rather harder to argue against coherently. The tax has failed on at least two fronts: by raising base salaries it fails to 'bash' bankers, as it was surely intended to do; nor does it make banks safer, since it increases their fixed expenses despite investment banking’s inherent revenue volatility.
It would be a mistake, however, to lump such a measure into a broader regulatory bonfire, as is often threatened. A post-Brexit race to the bottom will hardly help London’s cause. In investors’ eyes right now, the UK is unsettled enough.