Liz Truss’s inflation mandate | Financial Times
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Good morning. It’s Katie here again, demob happy for my third and final time filling in for Rob before taking a break myself, woohoo. It was my pleasure, really. I don’t know why Rob is whining about it all the time. (He doesn’t really.)
Feel free to keep saying hello at email@example.com, but don’t necessarily expect an answer if I’m drinking sangria during the day on my vacation, and remember that the real mastermind behind this whole operation is ethan. firstname.lastname@example.org, who routinely poses provocative questions to his elders and superiors. Okay, only the elderly, but regular readers of this newsletter know that anyway.
UK: this is fine
One of the real quirks of UK markets in recent weeks is that they are not responding to statements about economic or even monetary policy from the two contenders to take over Boris Johnson as the next prime minister. On July 7, Johnson announced that he would be retiring. Since then, yields on sterling and gold-plated bonds have remained stable. snoring.
Several possible explanations come to mind. One is that the candidates’ policies, especially those of frontrunner Liz Truss, would make no difference anyway. The other is that market participants think this is all campaign blunder and the policy will not be implemented. This bluffing could be a mistake.
If investors are worried at all, they hide it well. The only real market move is the FTSE 100, up 4 percent since Johnson’s announcement. This remains the only notable national stock index to have had a positive performance so far in 2022, which sounds great until you consider that companies in the index generate about 75 percent of their revenues abroad. So this is not a gamble on the UK or its political direction. However, it’s a bet on relatively unsexy companies digging or pumping things out of the ground. Yes, they’re part of the green revolution too, but when an asset manager described the UK stock market to me as a ‘corporate retirement home’, he was onto something.
Anyway, on to Truss, who isn’t sure of winning the leadership race, but you know.
Among her more market-sensitive and high-profile policies, she has pledged to review the Bank of England’s mandate if she lands the top job in September. In private, many investors and analysts are baffled by this, as hedge funds rub their hands in anticipation. In public, banks have generally been a little cautious about dealing with this elephant in the room, stung by the experience of assessing the relative pros and cons of Brexit in 2016, which has left some of them mired in accusations. of participating in Project Fear.
But Deutsche Bank has put a good and balanced spin on it.
It thinks Truss would launch a strategic review of the BoE around Sept. 21 — a possible date for an emergency budget. These talks were likely to be concluded quickly to prevent the BoE “losing credibility at a critical time in the economic outlook,” analysts Sanjay Raja and Shreyas Gopal wrote. Perhaps the simplest outcome would be to raise the inflation target of 2 percent to a new level, which the Treasury Secretary could unilaterally do.
A stricter, i.e. lower inflation target could boost sterling a bit, Deutsche believes, but it would probably be a bit academic, as the BoE expects inflation to rise above 13 percent (yes, one three) will be.
But something juicier like a Fed-style dual mandate with a jobs target or, seemingly more likely, a nominal gross domestic product target (an idea described by Paul Donovan of UBS Wealth Management as a “crazy idea”) would likely require new legislation. require, among other things, and have much more impact.
Deutsche’s analysis (shortened by me) is:
We think a shift to a headline GDP target of 4.5 percent would be perceived as moderate by the market and negative for sterling. The consensus is that potential (real) growth in the UK is low (around 1-1.5 per cent), due in part to weaker demographics and the prolonged productivity slump in the UK.
As a result, the market is likely to see inflation doing the heavy lifting to bring nominal GDP to target – in other words, the implied inflation target could be higher than the current one. This, in turn, would imply lower real interest rates, resulting in a fall in sterling.
A nominal GDP target also implicitly assumes that monetary policy can adapt flexibly and quickly to achieve the target. However, monetary policy works with a significant delay of about 12-18 months.
The BoE would also step into the relatively unknown as there is currently no other major central bank targeting nominal GDP.
A positive outcome for sterling would be if the inflation target is lowered without any other change in the bank’s independence or flexibility in execution. By contrast, we would expect the pound to weaken on confirmation of the suggestion that the bank could be asked to switch to targeting nominal GDP, or if they are forced to increase and then stick to forward guidance because of perceived political influence.
An overriding question here is what the point of this whole exercise would be. “No mandate would likely have produced significantly different results, as monetary policy only affects demand in the short term,” said Paul Hollingsworth, chief economist for Europe at BNP Paribas. “The alternative would have been to pressure demand so much that a recession would probably have already set in.” Excellent! Register us!
Jane Foley of Rabobank summarizes the situation very neatly:
Liz Truss continues her charm offensive against the members of the Tory party. However, its policies are not necessarily in line with the needs of investors.
Delicately set. Foley says sterling could fall to $1.14 in the next one to three months. It now stands at $1.21 and a little. Read more of her take on this topic today in a Markets Insight column.
If you’re watching from the sidelines and thinking, “Right, but British politicians certainly wouldn’t be taking non-urgent risks with economic and monetary stability at a delicate moment,” I would kindly suggest that you haven’t been paying attention in recent years.
If you’re quietly worried about all this, or vociferous concerns, or even if you think this is exactly what the country needs, our inboxes are open.
Catching Katie’s Eye
AQR’s Cliff Asness isn’t a man to waste his words, and his latest tinkering with value stock numbers has led him to ask out loud, “Is everyone there cray-cray?Parts of the market have “temporarily (I hope) gone mad,” he says, undervaluing value stocks to the point of being reminiscent of the great technology bubble at the turn of the century. He notices:
The past few months serve as a cruel reminder that a massive valuation disruption says very little about the timing of when it will fall again.
As my excellent colleague Bryce Elder noted last week, Baillie Gifford has put forward some, er, interesting thoughts about what can cause poor fund performance. To do read the annual report. It’s quite a bit. Also always read Bryce.
The strikers of Bank Underground (the BoE blog) have gone where few serious people have gone: to the metaverse. Readers, you may be shocked to learn that “widespread adoption of crypto in the metaverse, or any other setting, requires compliance with robust regulatory frameworks for consumer protection and financial stability”. Also, “as an open and decentralized metaverse grows, existing risks of cryptoassets can scale to have systemic financial stability implications”. Big “if” there. Enormous. Still, a thoughtful piece worth reading.
Technical analysis is: definitely a serious matter.
“Immodest, cynical and just plain weird.” Are you okay, Australia?
Apparently Larry Fink doesn’t find bitcoin “index of money laundering” Lake. Hard to say when the change of heart happened, but it must have been recent, as he said in October that he “not a student” of the digital asset “so I can’t tell you if it’s going to be $80K or 0”. Buyers of BlackRock’s new bitcoin trust may have a clearer picture. (On a related note, if you missed it, abrdn hs gt int crpto.)
So maybe past performance is an indication of future returns after all? In certain parts of private equity anyway, according to this bite-sized but quite satisfying Schroders analysis. tl;dr:
The past performance of private equity funds can provide useful information to consider how they might perform in the future. This is a very different picture from what we see with public equity funds.
Come on everyone loves surfing dogswhat difference does it make if there is no market relevance?
A good read
Wood pellets. So hot now.