As the third quarter of investors’ own annus horribilis draws to a close, market participants have been closely watching two, very different “Feds”. Last week, the global shipping company, FedEx, took the decision to withdraw its outlook for the fiscal year ending May 2023 and warned investors that the business would be making substantially less profit, from a lower revenue and, more ominously, that the full year outlook for 2023 is getting worse. The stock tumbled on the news, falling 21.40% on Friday 16th September.
FedEx warned investors that quarterly results will be badly impacted by deteriorating economic conditions in Asia, Europe and the US. As a result, it will go on a cost cutting mission, grounding planes, putting a moratorium on hiring and closing more than 90 offices, amongst other measures.
But why should we care? Well, FedEx is a truly global business and one of the few whose business model touches almost every part of the global economy. Therefore, it is seen as a global economic bellwether and such a negative outlook causes concerns for investors around the world. As the new quarterly earnings season ramps up, investors will be scrutinising the guidance given by company management for any clues about the economic outlook.
Given these signals of economic weakness, a good proportion of the investing community appears to be holding on to the belief that central banks in the developed world will “pivot” and start cutting interest rates, even though inflation remains uncomfortably high. The argument goes that central banks will not be willing to inflict the necessary economic pain to bring inflation down to target. Falls in the equity and bond markets, combined with higher interest rates, result in a tighter monetary environment and central banks will have no choice but to start cutting interest rates soon.
As we have discussed in these articles many times, we don’t think that central banks will come to the rescue of financial markets. Many have been explicit in their warnings of recession and some have used “whatever it takes” type language in their battle against inflationary forces. We have seen historic interest rate rises from the ECB in Europe, the Bank of England and the Riksbank in Sweden which raised its interest rates by a full 1% at their last meeting. Make no mistake, these are truly unprecedented times.
Whilst fuel prices have come down at the pump, inflation has become much broader, as shown in the top panel of the chart below, and there are signs that wage growth is rising fast too, with the possible exception of Europe, as shown in the bottom panel:
This goes some way to explain why the US stock market suffered so badly last week when the August inflation numbers came in higher than expected. The market was hoping for a fall in the Consumer Price Index of -0.10% versus the previous month but inflation accelerated by 0.10%. This caused the worst sell off in the S&P 500 since 2020.
All eyes on the Fed
So, from the economic bellwether of FedEx, investor attention now turns to the US Federal Reserve (Fed) who will announce the new US interest rate tonight (I am writing this on Wednesday 21st). Whilst the US inflation numbers continue to be uncomfortable, all things considered, we would be surprised to see anything other than a 0.75% rise from 2.50% to 3.25%. Although the market is pricing around 20% odds of a 1% rise (to 3.50%) we think that the Fed will be wary of ramping up the pace of interest rate rises and the potential impact on the US economy. Even though Jerome Powell has, effectively, confirmed that a recession is required to bring inflation down, the Fed will not want that recession to be any more deep and painful than it needs to be.
We also have the Bank of England (BOE) interest rate announcement tomorrow, which was delayed from last week due to the passing of Queen Elizabeth II. Again, we think that the current pace of rate rises will be maintained and that we will see a 0.50% rise from 1.75% to 2.25%. However, there is risk that the BOE decides to play catch-up with the US, Europe and Sweden by announcing a 0.75% rise to 2.50%. An outsized rate rise would go some way to support the ailing Pound which recently touched its lowest point against the US Dollar since 1985. The BOE would never openly admit intervening in the currency rates but Sterling weakness makes imports relatively more expensive and thus exacerbates the inflation problem.
Whatever they decide to do, we are concerned over the outlook for the UK and whether it can withstand the expected interest rates rises to come.
Keep calm and carry on?
We are in the midst of a regime change in the global economy from one where money in the financial system was cheap and plentiful, to one where the excess is being withdrawn and costs are increasing. This creates a huge amount of uncertainty and the risks of error, not just on behalf of investors but policy makers as well, are significant.
To invoke the war time slogan which, for a time, seemed to be emblazoned over everything from mouse mats to cushions, we don’t believe that this is a time to make any bold changes and that one should “keep calm and carry on”.
Until next time, stay well.