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Market Update
July 24, 2023

Hard Vs Soft Landings

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Week Ending 21 July, 2023

There is a clear change in sentiment around a Hard landing vs a Soft landing. The latter is gaining traction. Goldman Sachs is the latest to add its support with the odds of a recession in the next 12 months lowered to 20% (previously 25%). They do not think lowering inflation to an “acceptable level” will require significant damage to the labour market.

Where do we stand on AI? The main bottleneck is insufficient hardware. Investment in hardware is likely to surge while investment in software will continue to grow gradually. It is difficult to estimate the scale of investment we might see and the productivity it will generate. Past cycles driven by electricity and IT were driven by large investment cycles of some 2% of GDP…..but given the changing nature of each investment cycle and the impact each new technological revolution brings, I think the actual investment levels will be far higher. I still believe markets, economists, politicians and analysts are underestimating the severity of the current tightness in the labour market, globally. Wage growth is rising and as long as it adds inflationary pressure, then the pressure to find solutions (AI) will remain high too.

China: are we expecting too much? Real Q2 GDP rose 6.3% y/y and this was considered weak. Recently, markets have been disappointed by the perceived “lack of action” from Chinese authorities to stimulate the economy resulting in this sense that policymakers are being blasé. This week, the PBoC kept their 1y and 5y LPR (Loan Preference Rates) unchanged while authorities look at different ways to reinvigorate parts of the economy. I stress “parts of the economy” because China’s woes are not nationwide. It is an EM not a DM. this is one of the fundamental distinctions between the two – the closer a nation transitions to becoming a DM, the more universal the tools become. Why? Because as one’s economy adopts a more “level playing field”, policy makers can tackle problems in a more consistent way – and even this is not without its issues. However, in China it is questionable whether the authorities actually believe things are looking that bad that massive stimulus is needed. If you look at momentum, it’s ok. GDP growth y/y is rising though, lately, GDP growth q/q is bumbling along at the bottom. The past couple of quarters have been very soft – but then much of that can be explained by covid and then, to a lesser extent, by the weaker property situation. The PBoC has been clear – it remains on the sidelines but is ever-ready to step in if liquidity is required. They have stipulated they have room to cut rates if so required. Once again, we come down to management of expectations. My W-I-R for w/e 7th July referred to the same principle comparing US ADP job data vs Nonfarm Payrolls. This is no different.

There are three factors that drive the price of a security – Fundamentals, Macro and Technicals. Technicals are often underestimated and they comprise things like short interest, speculative interest, option interest and so on. At a Macro level, technical comprise things like Open Market Operations i.e. government bond issuance, durations, yield bid-offer and so on. In this regard, I have commented on something called the TGA (Treasury General Account). The TGA is essentially the Fed’s checking account and defines how much money the treasury has to pay for its daily funding needs. The chart below shows how low it had reached at the start of last year.

What we have witnessed is a slow build up in replenishing its reserves of short-term cash which, in turn, has prevented the front end of the yield curve steepening anymore, especially around the debt ceiling debate. One big danger wit the latter was that the only real way the Treasury could keep function was through higher short-term debt issuance which would drive up the yields required to entice investors. So far, that doesn’t seem to be happening in any significant way which has been a boost for equities – there is a correlation between the Fed’s reserves and stock market performance (MSCI World). The TGA level is already back up to 0.5TN and looks well capable of hitting 1TN in a smooth manner.

Lastly, we saw this week Russia renedge on the grain deal that was brokered by Turkey last year. This was preceded by an explosion on Russia’s flagship bridge connecting Crimea to the mainland. Conveniently, the explosion was not so severe and part of it was reopened quickly. To my mind it was a pure stunt that gave Russia grounds to justify a U-turn on the deal (by blaming events on two Ukrainian drones) – which it had long been threatening to do. The Black Sea deal allows for some 33mn tonnes of exports from Ukraine (51% = Corn, 27% = Wheat). How concerned should we be about another escalation in food prices? The full impact boils down to logistics and especially insurance costs. Already big insurers like Lloyds of London are reviewing insurance. The impact is worst on EM countries, many in Africa – Ghana, Nigeria and South Africa. Turkey’s President, Erdogan, will be discussing the situation with Putin when they meet in August. We have another quasi-oil situation – unless Russia turns its back on these EM nations, it will have to find a way to continue supplying them at a discount. That’s where logistics come into play – insurance alone is rocketing where available. Otherwise, Russia will choke them – that doesn’t bode well for the Russia / China alliance of EM nations. Looking at the latest wheat spot prices, yes prices jumped initially from $632.75 to $727.75 on the explosion and have now dropped back to $696.50. It is still well below the $1,006 back in Jan 2022. So how concerned should we be at this stage – not very.


Source: Refinitiv Datastream/Fathom Consulting
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Market Overview.