From war in Ukraine to fears of a recession

What next for investors?

08 April 2022

Our Chief Investment Officer talks about Ukraine, inflation, Covid, and the US yield curve inversion.

The current landscape

The tragedy in Ukraine has rightly continued to dominate the headlines and our thoughts are with those most affected. From an economics and markets perspective, the conflict has further spurred worries about the cost of living crisis in many countries, as well as energy supply more broadly.

The financial markets’ story of the year so far remains the sudden change in posture from the world's central bankers. As the prospect for aggressive interest rate rises linger, worries abound over whether central bankers are going to have to push the global economy into recession in order to get a handle on inflation. Meanwhile, Covid outbreaks reemerging in China remain a cause for concern.

Elsewhere, the recent inversion of the US yield curve – where longer term borrowing costs fall below shorter term borrowing costs – implies that short-term monetary policy has become too restrictive and may push the economy into recession. However, it is worth noting that there is no corresponding relationship between the size of the yield curve inversion and the gap before any ensuing recession. Furthermore, yield curve inversions don't cause recessions in and of themselves but provide a useful prompt to reexamine assumptions. We do not believe there is any action for investors to take right now.

As always, we recommend investors get invested, stay invested, and stay diversified.

PHIL ATTREED: Hello and welcome to the April episode of Monthly Market Insights. I’m Phil Attreed, Barclays’ Head of Wealth Specialists. Once again I’m joined by Will Hobbs, our Chief Investment Officer, so we'll try and assess the month in the rear view and make some hopefully informed guesses of what we might see in the month or so ahead.

Now of course it's been another rollercoaster of a month in investment markets to finish off what has been a pretty turbulent first quarter as well. So, Will, what would you characterise as the major features of the month just passed and also the quarter from an investor's point of view.

WILL HOBBS: Phil, yes there's been a lot hasn't there, let you say, again. So war, tragedy in Ukraine has rightly dominated the news and all of our thoughts and this is obviously further spurred, from an economics and markets perspective, it's spurred worries about the cost of living crisis in many countries, the incoming cost of living crisis in the UK, particularly parochially for us. And also energy supply, energy security more broadly among many other things.

The financial market story of the year so far though probably is still the sudden change in posture from the world's central bankers. It wasn't so long ago that this was expected to be a year where the central bankers would sit on their hands, as you know and now we're looking at aggressive interest rate rises, with moves following on from, moves already made essentially.

And now you've got these worries about whether central bankers are going to have to push the global economy into recession in order to get a handle on inflation. And alongside that you've got covid suddenly really emerging in significant cities in China, Shenzhen and Shanghai have the latest outbreaks.

And this context when you talk about the quarter to date that's seen the worst start to the year for global government bonds this millennium. You've seen diversified commodities be the best-performing asset class for the first quarter, much like most of last year, and some of the biggest moves have been among stocks that were the pariahs of the last economic cycle and vice versa. So it's really been quite a year so far. Alongside all of that extra tragedy which the world just simply didn't need.

PA: Now if we dive into a little bit more detail and without getting too technical, the yield curve and the recent brief inversion. Now I recall this being a topic, Will, that we spent a long time on calls in previous years talking about and then it disappeared for a while. But it looks like it's back and traditionally it's been heralded as a reasonably reliable predictor of recessions. Does that have your team worried?

WH: We're never worried about anything, let's say it that way, cool and calm as always. Well certainly they are, I don't know about me. But I think there's probably three points to make here, with regards to context on a yield curve inversion.

So the yield curve, like you say, what it is  -  when longer term borrowing costs are below shorter term borrowing costs for a government in question. Mainly people look at the US because the US is, well for a number of reasons, that's one of the economies where this yield curve inversion has proven to be most statistically significant, most meaningful but also obviously it's still by some distance the most important economy for the world economy in terms of future trajectory.

And like I say there's a few points.

One: it's really about the intuition and that context. Now the intuition behind this is that if your longer term borrowing costs are going below your shorter term borrowing costs that is the market saying, all things being equal and I’m skipping a lot of corners here, that short-term monetary policy is too restrictive or is about to become too restrictive and you're about to push the economy into recession, basically like I say there's a few shortcuts.

Now if you look at the moment it's hard to say that policy is close to restrictive really in much of the developed world, you've got negative real interest rates, sharply negative in some cases. Now it may get closer to restrictive territory if central bankers carry on with their plans but we're certainly not there yet and much can happen over the next year so it's probably a bit early on that front.

Two: like all the best fairground soothsayers, the yield curve likes to keep its predictions pretty vague. And so there is no corresponding relationship between the size of the yield curve inversion (i.e. the gap between the two) and the correspondingly ensuing recession.

And I think the gap between a yield curve inverting and the actual recession occurring since 1965, has ranged between nine and 34 months, that's since the mid-60s, so quite a vague, it's a little bit like me saying it's going rain this summer. It's not amazingly, it doesn't require incredible foresight to be able to see and unfortunately recessions are pretty much like rain is to the English summer. They're just part of economic life.

The third point and I think this is really important, is that yield curve inversions don't cause recessions in and of themselves. They are a useful summary statistic, let's say. So they contain some information for us and usually what I would say is, or what the team would say is that they're a useful prompt to be able to re-examine some of your assumptions and have a look around.

We've got our own in-house recession indicator which takes in a broader set of indicators and at the moment that's not flashing amber, it's still pretty sanguine about the risks of a recession ahead, imminent recession ahead. So we're keeping an eye on all of these things but I don't think, it's not (a) an actionable thing for investors to think about and (b) I think the context this time is quite important.

PA: Turning to inflation, when do we think we might get enough information on this and I suppose the wider economy? I guess the summer months are going to be quite important particularly around that inflation story, it's been driving a lot of the headlines and market moves year to date aside from of course the Ukrainian crisis.

WH: I think that's right, Phil, it is the big economics story in a way. Now one of the things is, there are some forecasters who've long pointed out rightly that as you lap some of the price surges from last year and stuff, in the US things like used cars and so on, there was a few other odds and ends, that as you lap those you get, unless used car prices go up by the same amount or more again, you should get some easing effect in some of the inflation data over the course of the summer.

Obviously the behaviour of commodity markets is going to create a significant amount of noise and inflation data for a while to come. It's unclear, I think over the course of the summer I think it's right, you are going to get more information on what's here to stay. But the thing to still focus on I think and this is where let's say evidence is pretty mixed, the jury's still out whatever else you want to use, it's really about the interaction of expectations with what you start to see in terms of wages, price setting that kind of thing.

Now at the moment in the UK there are some concerns about inflation expectations. They're not easily measured, remember, these inflation expectations and they're not speaking with one voice anyway. But this is the concern. That's where you start to get more problematic is when consumers and businesses cease to believe in the central bank as an effective inflation-fighting force and you start to get, that's where you start to get that wage price spiral that really does keep everybody up at night in truth.

But we're not seeing sustained evidence of that yet but definitely we can see the reason why central bankers are getting busier even if for some households this is an extremely unwelcome extra burden on top of the cost of living crisis that's just getting worse in the short term.

PA: Absolutely and then just one final point I thought we'd end with. I recently saw you making a point or heard you make a point about the economic benefits of diversity and inclusion, I thought that was quite an interesting end to share with our listeners.

WH: Yes, Phil, it was when I was reading, I was studying for a university essay for the degree, the Masters I’m doing at the moment, and there's this guy, a very famous economic historian called Joel Mokyr and he was arguing, very convincingly I thought, that there's three necessary conditions for a technologically creative society.

 One, you need a cohort of inventors, ingenious people who are willing to break with the status quo, challenge their physical environment so on; two, you need the right incentives and that can be ability to own stuff, private property rules, protection from confiscation, those things or random acquisition by monarchs; and three, he made an interesting point about diversity and tolerance.

 And here the point is really about, it encapsulated another quote from another very interesting economist, I think and he wrote, it's a lovely quote I think: “Technological progress requires above all tolerance towards the unfamiliar and the eccentric.” And this is the whole point that in a way in order to be technologically creative, in order to come up with productivity, many people are arguing that you can just educate a load of people in a certain subject and just pour them into an area.

I think that underestimates how this thing happens; the elixir of productivity growth is often making sure that there is dissent in economy, debate, and the ability to incorporate the eccentrics and the misfits into your growth process. That is the lesson from the past and I think it speaks of diversity and inclusion, having an economic rationale as well as one a civilised society should endorse and abide by fully. So that is the key in a way, it's finding ways to incorporate everybody into your process so that you can come up with new and fresh ideas about how to grow and how to improve.

PA: Absolutely, Will, thank you. As always useful insights as we continue to navigate what is a challenging period both politically and economically and thank you, our viewers and listeners, for joining us. If you'd like to hear more, as always, seek us out on our weekly podcast Word on the Street where we share all of our latest views on developments.

From war in Ukraine to fears of a recession

As part of our aim to keep clients and customers informed of our current investment views and how these themes are impacting our portfolios and funds, Phil Attreed, Head of Wealth Specialists, talks with Will Hobbs, Chief Investment Officer, about Ukraine, inflation, Covid, and the US yield curve inversion.

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