Financial Update from Brewin Dolphin - 10 February 2023

February 2023

The Weekly Round-up

Friday 10 February 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, analyses Russia’s cut in oil production and UK economic growth figures.

After the deluge of economic data from developed markets, we had expected to focus more on some of the emerging markets this week. Russia, which now exists within the investment dark regions of a sanctioned economy, reflects some of the same challenges facing more acceptable peers. Inflation is high, above 10%, but this is less unusual for Russia than, say, the UK. Furthermore, prices are starting to come down. The unemployment rate, at less than 4%, is the lowest since reliable statistics have been kept. Economic momentum is weak though; retail sales have contracted by 10% over the last year, but like the rest of the world, purchasing managers’ indices suggest stability is returning.

Russia jolted the markets on Friday by announcing a cut to its oil production. Russian authorities had been threatening to retaliate against EU bans to energy imports and enforced maximum prices for Russian oil, but for a long time there was no reaction. This week, the price of oil rallied on the news, although it may be that this is more of a response to having a reduced energy market than the aggressive move Russia is billing it as.

Demand for oil should be strong enough to support prices this year, despite concerns over a possible recession. The global economy is currently proving more resilient than feared, and the reopening of China should see a continent-sized increase in energy demand as Chinese air travel in particular returns to pre-pandemic levels. China’s credit growth accelerated in January, reflecting the resumption of economic activity even as services inflation remains fairly muted.

UK GDP

The UK avoided a recession in 2022, according to the preliminary estimate of GDP for the final quarter. After a decline in the third quarter, a second decline would have implied a recession. However, when the data were released they showed the economy had neither grown nor shrunk. This will save the headline writers some ink but otherwise is fairly inconsequential. A second quarter of negative growth, if it had happened, would be very modestly negative. The term ‘technical recession’ has been coined to described two consecutive quarters of negative growth without the soaring unemployment that marks out an effective recession. Indeed, the final numbers for the fourth quarter may yet be revised lower when they are released at the end of March. Recently, though, GDP has been more frequently revised upwards than downwards.

Perhaps more worrying was the momentum in the economy. Despite being flat over the quarter, the monthly data shows that growth was 0.5% in October, more or less flat in November and -0.5% in December. December was beset by poor weather and strikes, some of which have abated during 2023.

The purchasing managers’ indices suggest the UK economy did shrink last year. The manufacturing sector survey recorded a sixth straight month of implied contraction in its latest results. The more influential services sector has seen four such readings, with the latest being the weakest, suggesting the improvement in the weather has not brought better economic activity.

Out of 35 estimates for UK growth in the first quarter of 2023, 34 are negative. They are universally negative for Q2, the start of which will see tax increases hitting all UK workers, skewed towards higher earners. These estimates are probably a little stale, with the external growth picture looking a little better. This week saw the National Institute of Economic and Social Research (NIESR) bucking the trend by suggesting the UK economy will avoid a recession this year. However, its underlying conclusion was not wildly at odds with other forecasters, the UK is likely to make little economic progress during 2023.

BoJ job

Japanese prime minister Fumio Kishida will nominate Kazuo Ueda to take on the governorship of the Bank of Japan when Haruhiko Kuroda retires in April. This was a surprise after press reports earlier in the week that Masayoshi Amamiyawould be taking over. Amamiya was the continuity candidate and was seen as the most likely to continue with the ultra-dovish stance of Kuroda. As such, any other candidate was likely to be seen as relatively hawkish.

What is known about Ueda is that he is not Amamiya, who is understood to have turned down the prestigious role. Therein lies the real challenge for the BoJ. Although it might seem that Japanese inflation is at last above the central bank’s target, and although the latest wage data suggest employees are being successful in driving up their compensation, Kuroda maintains that inflation is not yet on a sustainable trajectory. Effectively, he is conceding defeat at a time when the BoJ’s huge share of the JGB market has made continuation of his policies impossible. In that context, you can understand why a so-called continuity candidate might think twice about taking the role.

The announcement of Ueda is a surprise, but the element of surprise is policymakers’ best weapon in this environment. Investors have been testing the BoJ’s resolve for many weeks now, speculating that bond yields would need to rise (meaning bond prices would fall) and forcing the BoJ to make larger bond purchases to defend the upper yield threshold at a time when, ideally, they would be tapering off as the economy and inflation recover.

Ueda is understood to have been critical of negative interest rates, which adds to the impression of a hawkish candidate. However, it can be dangerous to read too much into policymakers’ views before they take their roles. Catherine Mann was expected to be a dovish member of the UK’s Monetary Policy Committee but she became possibly the most hawkish member.

Liquidity

The BoJ has been an outlier, providing liquidity to the market while other central banks are withdrawing it. Should it eventually manage to escape the yield curve control policy, that flood of liquidity will likely reduce (depending upon what policy framework they replace it with).

The evolving policy environment in Japan makes a strong yen and higher yields more likely than not. That’s bad news for stocks, although currency gains might compensate foreign investors. However, the interest rate-sensitive sectors, such as banks and insurance, should benefit.

The liquidity environment has been a supportive backdrop for markets, which have rallied against most investors’ fears. Liquidity has been boosted from Chinese credit markets, the Japanese efforts to maintain the yield curve control corridor and the US Treasury special measures, which aim to delay the eventual debt deadline when the statutory government debt limit will need to be raised to avoid a US sovereign default. With plenty of historical precedent suggesting that a deal will eventually be done, investors will assume that default is avoided. In the meantime, though, much brinksmanship is likely between the Republicans and Democrats.

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