25 Mar 2022
It seems to me that there are really three forms of government: governments which trust their people, governments which don’t trust their people and governments that steal from their people.
Sometimes it is difficult to distinguish between the last two. Basically, this gives rise to democracies, autocracies and kleptocracies. Russia, throughout its rich history, has never really had a government that trusted its people; perhaps that reflects the sheer scale of the country. And not surprisingly, truth has been a casualty of this war: Russia and China, among others, cannot let their people see the whole picture. However, I feel we should be careful we don’t start down the same route. Banning views, however much you may disagree with them, is not usually a good thing; seizing property without due process risks undermining values we represent.
What is occurring in Ukraine is a humanitarian crisis, and incredibly sad to see. It is also sad, in a different way, to see the ‘Great Leap Back’ that the Russian government has imposed on its people. Without a capitulation from Russia or a change in leadership, neither of which seems likely, the alignment between the major autocracies will gain ground under the agency of war. I have taken to reading the China Daily newspaper (English version I should add) and what is striking from their editorials is not the strength of support for Russia but the hostility towards the US and NATO. Praise is heaped on France and Germany but the US and UK are seen as warmongers. So, in an ironic twist, it looks possible that Russia will move into the orbit of China, becoming the ‘commodities subsidiary’ of China plc, in contrast to the notion of recreating the western orientated greater Russia sought by past ‘Greats’. History can be a tough master when leaders look for legacy.
From an investment viewpoint this means a further pull back from globalisation, higher energy costs, more government spending and higher debt levels. This will translate into lower growth and toleration of more inflation. But it could also lead to an acceleration of decarbonisation, more emphasis on social and governance issues within the ESG framework (too many easy excuses in some parts of the world) and the repatriation of innovation which had been outsourced to unreliable jurisdictions. So, there are some potential silver linings.
Central banks in the US and UK were not dissuaded from tightening rates last week The tone from the Federal Reserve (Fed) was hawkish; they delivered the expected 25bps rise but the ‘dot plots’ imply six more rate rises this year – assuming they are 25bps each. The Fed was a bit more downbeat on GDP with growth revised down to 2.8% for the current year. However, there was talk about the underlying strength of US economy and the Fed’s commitment to bring inflation down – the latter was the crucial message they wanted to get across.
As expected, the Bank of England (BoE) also raised rates by 25bps, taking the bank rate to 0.75%. However, the tone was markedly different from the Fed, with one member voting for no increase. The BoE is clearly worried about the negative impacts of higher commodity prices on real household incomes and activity. We are being prepared for further hikes, but not at the pace suggested by previous BoE comments. This highlights their dilemma: Consumer Price Index (CPI) inflation is now expected to hit 8% in Q2, 1% higher than their recent estimate. Against that background 0.75% official rates look anomalous but the BoE is saying that inflation will fall back more strongly than previously expected given the squeeze. Will inflation fall back quickly enough for the BoE to retain credibility?
In markets, gilts took heart from the BoE with yields bucking the global trend higher. The yields on 10-year UK gilts stayed around 1.5% whilst we saw yields move up in the US and euro area. In the US the move to 2.15% compares with the 1.15% yield of February last year. In Germany, the 10-year yield approached 0.4%, a long way from the -0.5% of Q3 2021. With a nod to an impending global slowdown implied inflation fell last week in most markets.
Credit markets are behaving pretty well. Yes, sterling non-gilt spreads have widened a bit in recent weeks but given the volatility in financial assets, the moves have been modest. Bank and insurance debt remain under pressure but asset backed securities (ABS) continue to do reasonably well. Encouragingly, the market uncertainty has seen some secondary market offers in ABS, so we have been able to add to positions.
High yield markets actually did well last week, despite the global headlines. A bounce back in Chinese equities helped sentiment in emerging market credit – after a very torrid few weeks.
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