Sunday, October 2, 2022
HomeEconomyLiz Truss’s inflation mandate | Financial Times

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 I take a break of my own, woohoo. It’s been a pleasure, truly. I don’t know why Rob whinges about it all the time. (He doesn’t really.)

Do feel free to continue saying hi at katie.martin@ft.com, but don’t necessarily expect an answer if I’m sipping sangria in the daytime on my hols, and remember the real brains behind this whole operation belong to ethan.wu@ft.com, who routinely asks bracingly probing questions of his elders and betters. OK just elders, but regular readers of this newsletter know that anyway.

UK: this is fine

One of the real oddities of UK markets in the past few weeks is that they are not responding to pronouncements on economic or even monetary policy from the two contenders to take over from Boris Johnson as the next prime minister. On July 7 Johnson announced he would quit. Since then, sterling and gilt yields have been flat. Snore.

Several potential explanations spring to mind. One is that the candidates’ policies, particularly those of frontrunner Liz Truss, would make no difference anyway. The other is that market participants think this is all campaign bluster and the policies will not be implemented. This bluff-calling could be a mistake.

If investors are worried at all, they are hiding it well. The only real market movement is the FTSE 100, up by 4 per cent since Johnson’s announcement. This remains the only notable national stocks index to put in a positive performance so far in 2022, which sounds great until you consider that companies in the index generate about 75 per cent of their revenues overseas. So this is not a bet on the UK or its political direction. It is, however, a bet on relatively unsexy companies that dig or pump stuff out of the ground. Yes, they’re part of the green revolution too, but when one wealth manager described the UK stock market to me as a “corporate old people’s home”, he was on to something.

Anyway, on to Truss, who is not certain to win the leadership race but, ya know.

Among her more market-sensitive and eye-catching policies, she has pledged to review the Bank of England’s mandate if she were to snag the top job in September. In private, many investors and analysts are aghast at this, while hedge funds are rubbing their hands in anticipation. In public, banks have generally been a little cautious to address this elephant in the room, stung by the experience of opining on the relative merits and demerits of Brexit back in 2016, which got several of them tangled up in accusations of participating in Project Fear.

But Deutsche Bank has had a good and balanced swing at it.

It reckons Truss would launch a strategic review on the BoE around September 21 — a potential date for an emergency Budget. This consultation would likely wrap up quickly to avoid the BoE “losing credibility during a pivotal period in the economic outlook”, analysts Sanjay Raja and Shreyas Gopal wrote. Possibly the simplest outcome would be to shift the 2 per cent inflation target to a new level, which the chancellor of the exchequer could do unilaterally.

A stricter, ie lower, inflation target could boost sterling a bit, Deutsche believes, but it would likely be a little academic while the BoE expects inflation to hit more than 13 per cent (yes, one three) by the end of this year.

But something more juicy like a Fed-style dual mandate with a jobs target or, seemingly more likely, a nominal gross domestic product target (a notion described by UBS Wealth Management’s Paul Donovan as a “wacky idea”) would likely require new legislation, among other things, and be much more impactful.

The analysis from Deutsche (abridged by me) is:

We think a shift to a nominal GDP target of 4.5 per cent would be taken dovishly by the market, and would be negative for sterling. The consensus view is that potential (real) growth in the UK is low, (c. 1-1.5 per cent), partly as a result of weaker demographics and the UK’s longstanding productivity malaise.

As a result, the market will likely see inflation doing the heavy lifting to get nominal GDP to target — in other words the implicit inflation target could be higher than the current one. In turn this would imply lower real rates, with sterling likely to fall as a result.

A nominal GDP target also implicitly assumes that monetary policy can adjust flexibly and speedily to meet its target. However, monetary policy works with a sizeable lag of around 12-18 months.

The BoE would also be taking a step into the relative unknown, with no other major central bank currently targeting nominal GDP.

A positive outcome for sterling would be if the inflation target is lowered without any other changes to the bank’s independence or flexibility in implementation. By contrast, we would expect sterling to weaken on any firming of the suggestion that the bank could be asked to switch to targeting nominal GDP, or if they are forced to increase and then adhere to forward guidance on account of perceived political influence.

One overriding question here is what the point of this whole exercise would be. “No mandate would likely have achieved meaningfully different outcomes as monetary policy only impacts demand in the short term,” said Paul Hollingsworth, chief European economist at BNP Paribas. “The alternative would have been to squeeze demand to such an extent that a recession would likely already have happened.” Great! Sign us up!

Rabobank’s Jane Foley sums up the situation quite neatly:

Liz Truss continues her charm offensive aimed at Tory party members. Her policies, however, are not necessarily in line with investors’ needs.

Delicately put. Foley says sterling could drop as low as $1.14 in the next one to three months. It’s now at $1.21 and a bit.

If you are watching from the sidelines thinking “right but surely British politicians wouldn’t take any non-urgent risks with economic and monetary stability at a delicate time”, then I would gently suggest you have not been paying attention for the past few years.

If you are quietly worried about all this, or noisily worried, or indeed if you think this is exactly what the country needs, our inboxes are open.

Catching Katie’s eye

Cliff Asness of AQR is not a man who minces his words, and his latest number-crunching on value stocks has led him to ask out loud: “Is everyone out there cray-cray?” Parts of the market have gone “temporarily (I hope) insane”, he says, undervaluing value stocks to the point where it’s reminiscent of the great tech bubble from the turn of the century. He notes:

The past couple months serve as a cruel reminder that a massive valuation dislocation says very little about the timing of when it falls back to earth.

In a crowded field, this is the funniest “sorry but you can’t have your money back” announcement from the crypto space of all time. Somehow the tweet is even better. It has anime.

As my excellent colleague Bryce Elder pointed out last week, Baillie Gifford has put forward some, er, interesting thoughts on what can cause poor fund performance. Do read the annual report. It’s quite something. Also, always read Bryce.

The pointyheads at Bank Underground (the BoE blog) have gone where few serious people have gone before: to the metaverse. Readers, you will be shocked to learn that “widespread adoption of crypto in the metaverse, or any other setting, would require compliance with robust consumer protection and financial stability regulatory frameworks”. Also, “if an open and decentralised metaverse grows, existing risks from cryptoassets may scale to have systemic financial stability consequences”. Big “if” there. Huge. Still, a thoughtful piece worth a read.

Technical analysis is definitely a serious thing.

Unbecoming, cynical and just weird.” You OK, Australia?

Apparently Larry Fink doesn’t think bitcoin is an “index of money laundering” any more. Hard to say when the change of heart happened, but it must have been recent, since in October he was saying he’s “not a student” of the digital asset “so I can’t tell you whether it’s going to $80K or 0”. Buyers of BlackRock’s new bitcoin trust may have a clearer view. (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 bits of private equity anyway, according to this bite-size but quite satisfying analysis from Schroders. Tl;dr:

The past performance of private equity funds may provide some useful information to help think about how they might perform in future. This is a very different picture to what we see with public equity funds.

C’mon, everyone loves surfing dogs, who cares if there’s no markets relevance?

One good read

Wood pellets. So hot right now.

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