Fed treads the line

The Noise

• The UK economy grew at its fastest pace since last summer when certain coronavirus restrictions were lifted. The value of goods and services produced by the UK economy rose 2.3% in the month of April. Compared to pre-pandemic levels of GDP, the level was 3.7% below the level in February 2020.
• Leaders of the G7 economies convened for a three-day summit beginning on Friday. One policy set to be announced is the provision of 1bn coronavirus vaccines for poorer countries as part of a plan to “vaccinate the world” by the end of 2022. Western governments have been criticized for hoarding the bulk of global vaccines, with Britain stepping up to offer 100 million doses, as is due to be announced by Boris Johnson on Friday.
• Last weekend, G7 finance ministers struck a deal on a radical new tax on the world’s 100 top multinationals. The tax would be levied where companies make their sales and not where they are incorporated, a blow to firms incorporated in jurisdictions with favourable tax codes. The stock market’s response has been one of apathy as share prices did not dip because of the announcement.

The Numbers

Data released yesterday showed US consumer prices rising in May at the fastest pace seen since 2009,echoing much of the sentiment which appears to have been underlying market expectations over the last few weeks. Whilst the Federal Reserve insists this inflation is transitory to justify its inaction, the definition of “transitory” is open to interpretation. Driven by a vastly expanded money supply and a number of longer-term trends, it is perhaps more likely that inflation will remain high for some time.

The challenge for the Fed is to maintain its ultraaccommodative policies (and hence allow inflation to remain elevated) without the market panicking that the  has lost control and is going to have to raise rates. This so called “taper tantrum” behaviour was observed back in 2013 when government bonds sold off rapidly in response to the Fed hinting that it was slowing down its quantitative easing (bond buying) programme.

For now, the Fed is managing to walk this tightrope as despite higher prints of inflation – which might ordinarily indicate that the Fed is going to have to tighten policy – the market reaction has been muted. Whilst government bonds have sold off slightly this week, the magnitude of the reaction has been small and the equity market has played ball, up slightly over the week.

We have spent much of the last few weekscontemplating how these dynamics will play out and ensuring portfolios are positioned accordingly. With inflation linked earnings exposure achieved through our property and infrastructure allocations and a suite of well-positioned businesses able to weather a rising cost environment, portfolios have the necessary defences in place in the event that this environment materialises.

At Sanlam we are excited for the Euros, even if they are a year late. The powerful optimism of English, Welsh and Scottish fans is infectious and a wonderful way to begin the summer. Interestingly, old rivalries die hard, a fact underscored by reports that the second and third bestselling football shirts in Scotland were those of Croatia and the Czech Republic, England’s other group rivals. It’s great to have some normality restored, even if it is other teams wanting England to lose.

We look forward to watching the tournament and being shocked when England go out to a country with a population smaller than Coventry.