Financial Update from Brewin Dolphin - 21 April 2023

April 2023

The Weekly Round-up

Friday 21 April 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, analyses better-than-expected GDP figures from China, a slump in UK retail sales, and the impact of declining energy prices.

Markets drifted a bit during the third week of April, with stocks and bonds generally little changed.

In the US, bank lending showed signs of growth again in early April according to weekly data. It is worth being a bit cautious on that as the data does get revised; nevertheless, it seems the worst of the financial turmoil is probably behind us. Despite this, Treasury secretary Janet Yellen acknowledged that lenders pulling back credit supply may do some of the Federal Reserve’s work for it, but not enough to change her economic outlook.

China growth beats forecasts

China reported GDP growth of 4.5% during the year to March. This was stronger than expected as the economy slingshots out of Covid-zero. The driver was retail sales, which also beat forecasts, while industrial production and capital expenditure lagged. The economy is reorientating from investment towards consumption which is considered a more viable long-term mix of activity. That has long been an objective of the Chinese Communist Party and has become coupled with the drive to rid the real estate sector of its excesses. Property investment continued to contract, weighing on overall construction despite a strong contribution from state infrastructure. That came at a cost, with the fiscal deficit widening. So while the recovery is more lacklustre than in previous cycles, there is limited scope for the state to do more to directly raise growth. China left interest rates on hold this week, but may well to need to provide more monetary stimulus as the year goes on if the consumer recovery stalls.

Spending to recovery

Consumption-led recoveries may be something of a novelty in China, but they remain the norm for other regions. Today saw the release of provisional estimates of the purchasing managers’ indices (PMIs) for a number of regions. These provide the best gauge of how economies are performing at the moment. Just like in China, the news is mixed with the services sector generally making progress (expanding at an accelerating pace) while the manufacturing sector, in stark contrast, enters an ever-deeper contraction across Europe (including in the UK).

Despite the apparent buoyancy of the UK services sector, retail sales fell disappointingly sharply. If that seems unusual, then it largely reflects the fact that companies are selling less goods but at higher prices, with the latter meaning that overall turnover is up. Indeed, the most eye-catching economic news of the week for the UK was Wednesday’s inflation data, which showed inflation slowing, but only marginally. The good news here is that next month will see a very sharp drop in the year-on-year rate of inflation, but while that might keep inflation off the front pages, the reality is still that core inflation remains uncomfortably high at 6.2%.

Despite the subsequent disappointing retail sales figures, and Monetary Policy Committee member Silvana Tenreyrou’s concern that the impact of rate hikes is yet to be felt, the markets are confident that rates will rise by 0.25% in May, and then quite possibly again over the summer. Core inflation is uncomfortable because it is likely to be affected by the tight labour market. That remains a feature of the UK economy, although wages are slowly moderating and might do so faster if headline inflation were to come down.

Land of the rising yield

This pattern of progress on headline inflation but anxiety over core inflation remains a consistent theme. Last night, Japan released year-on-year inflation numbers for April, which were a much more sedate 3.2%, down from 4.3% in January. As ever, it was energy dragging the rate down whilst core prices accelerated to their fastest pace since 1981. This is an awkward precursor to the first Bank of Japan meeting under its new governor Kazuo Ueda. For now, as in other regions, wages are rising at a historically fast pace, although we are seeing those rates slowing. The PMIs suggest a slight improvement in Japan’s manufacturing sector but a moderation of services sector growth. The higher share of services companies reporting higher output prices suggests that inflation remains an ongoing challenge.

This raises the question once more of whether the Bank of Japan will be able to retain its current yield curve control policy and thresholds. The ten-year government bond yield has begun to creep up towards the upper threshold once more, despite a pick-up in bond purchases by the Bank of Japan. It seems likely that the Bank will feel compelled to drop this policy, which was instigated by former governor Haruhiko Kuroda and which Ueda has never seemed to have much time for. We suspect rising yields in Japan would be accompanied by rising yields outside Japan. Overseas bonds would seem less attractive if they didn’t, and the Bank of Japan will not feel compelled to keep acquiring so many bonds.

Energy prices

With the difference between headline and core inflation in focus, it makes sense to think about energy prices. The impact of declining energy prices will vary depending on each region’s commodity appetite. In the US, gasoline prices reach their year-on-year nadir in June, after which they should exert less of a drag. Whereas in Europe, a glut of natural gas is forming meaning that prices are close to their lowest levels since mid-2021.

They are, at last, at levels which should result in price declines for UK consumers, which would be a major boost. If the global economy slows, as most forecasters expect, industrial metals and energy will see lower demand. However, we have already seen the willingness of OPEC+ to cut production to protect prices. There is also growing concern about a possible El Niño weather formation, which results in drier-than-normal weather conditions in Asia and wetter conditions in South America. Sugar prices have been rising due to tightness of supply, which will hopefully be alleviated by production surplus over the coming year. The typical impact of an El Niño is to depress harvests by enough to turn that surplus into a deficit, as crops become harder to grow in the east and harder to harvest in the west.

The value of investments can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.