Market Update – 10th February 2021.

11th February 2021

Global equity markets continue to move higher given the potential reflation of the global economy – no doubt helped by the $1.9tr US fiscal stimulus package that is currently working its way through Congress, coupled with the better-than-expected company result session and the rapid rollout of coronavirus vaccines.

Interestingly, this has resulted in newspaper articles being dominated by talk of an imminent return of inflation – and with it, tighter monetary policy via higher interest rates.  In fact, here in the UK, thanks to the early vaccination success, we have seen the pound strengthen to over $1.38 against the US dollar (a level not seen for nearly 3 years) on the expectation of higher UK interest rates.

Yes, the early vaccine rollout success means that we should all be able to look forward to better days in the weeks and months ahead, but it is wrong to expect higher interest rates anytime soon.

Additionally, reflation shouldn’t be confused with inflation.  Reflation is the return of global economic growth following the coronavirus lockdown induced economic contraction; while inflation is the uptick in the price of goods and services.

While we understand the simple argument that historically low interest rates coupled with government fiscal stimulus will unleash a massive spending surge once lockdown restrictions are lifted and the economy reopens – but in reality it isn’t that straightforward.

As we highlighted in the last Market Summary (please see here), with oil trading back over $60 for the first time since the coronavirus outbreak, we will see a technical headline increase in inflation as last year’s coronavirus induced collapse sets up a sharp increase in the coming months.

However, we believe the BoE (and all the other major central banks for that matter), will ignore this inflation as it is only transient – i.e. it is the pass-through of  distorted prices, rather than inflation caused by excess demand.  In fact, the underlying core inflationary pressures remain subdued as technology continues to boost supply and/or reduce costs – and if anything, the coronavirus outbreak has only accelerated this trend.

Furthermore, unemployment around the world is much higher today than before the coronavirus outbreak – and in the UK, while the government’s job retention (furlough) scheme has been a success in keeping unemployment numbers down, it doesn’t stop the millions still furloughed being worried about the security of their jobs which will impact consumer confidence and spending – and given the importance of the consumer to economic growth, central banks will want to deter saving and encourage consumers to spend and businesses to invest.

Moreover, central banks have indicated that if inflation was to rise, they would be willing to accept inflation running slightly above their 2% target given inflation has, by and large, run below target for over a decade (despite low interest rates and QE).

As a consequence, there is currently no need to get nervous:  higher interest rates remain many years away.

In fact, despite the fact that the BoE last week said it wasn’t close to adopting negative interest rates, we still wouldn’t be surprised if the next move in the UK is down.

Although the UK is well ahead of most countries when it comes to the percentage of the population vaccinated, the UK still faces a number of challenges – for example, new coronavirus strains could easily undermine efforts to lift the current lockdowns, while new Brexit customs checks are clearly challenging trade.  And as we saw in yesterday’s retail sales data from the British Retail Consortium, despite a sharp increase in grocery spending, total retail sales during January was 1.3% lower than January 2020, while over the past three months, total non-food sales fell 5.6%.

So in summary, while the reflation of the global economy and global equity markets is fully understandable, talk of a permanent resurgence in inflation and higher interest rates is not.

In fact, data from China this morning showed CPI inflation was -0.3% (i.e. deflation), while later today the US will release its CPI inflation data for January – and we aren’t expecting a material change from December’s readings of 1.4% and 1.6% for headline and core inflation respectively.

Investment Management Team