GOVERNMENTS TOLD TO ALIGN FISCAL AND MONETARY POLICIES TO GET INFLATION UNDER CONTROL

GOVERNMENTS TOLD TO ALIGN FISCAL AND MONETARY POLICIES TO GET INFLATION UNDER CONTROL

This week it was the Bank for International Settlements’ turn on the subject of inflation. Aside from encouraging central banks to stay the course, the BIS pointed out that getting inflation down is made harder when fiscal policy is running counter to monetary policy. The BIS’s solution is to encourage developed governments where inflation is a problem to raise taxes or curb spending as the fastest way to end the inflation problem.

By coincidence, Joe Biden effectively launched his re-election campaign and the topic he is keen to focus on is his Bidenomics stimulus programme. Biden’s poll ratings are not great and his advisers think he’s not getting the credit he is due from his stimulus. Although he is restricted by a Republican controlled lower chamber of Congress, the temptation for some form of extra stimulus in advance of next year’s elections must be great. Rishi Sunak and Jeremy Hunt face an even thornier dilemma in the UK. High inflation means further stimulus makes even less sense here, but a tax cut in advance of the next general election is one of the few options left to address the Conservatives’ terrible polling numbers.

US: STRONG ECONOMIC DATA COMPLICATES FIGHT AGAINST INFLATION

The US economy remains robust as durable goods orders and house prices have risen for the third month in a row and consumer confidence continues to recover. At this week’s annual meeting of central bankers in Portugal the European Central Bank, Bank of England and Federal Reserve all committed to keeping interest rates at restrictive levels to curb inflation. The US economic data has added support to the more aggressive stance and this pushed government bonds down and drove yields up.

Meanwhile, President Biden has kicked off his re-election campaign by highlighting the success of his economic policies while the Bank of International Settlements pointed out that the fight against inflation is harder if governments and central banks are at cross purposes. Biden is unlikely to pass any further stimulus after losing overall control of Congress, but Rishi Sunak may be tempted by a well-timed tax cut in advance of the next general election.

BANKS: LARGEST US BANKS PASS ANNUAL STRESS TESTS

Just over three months since the collapse of Silicon Valley Bank and First Republic, all the large US banks passed the latest stress test by the Federal Reserve. The worst case scenario predicted total losses of $541bn but the Fed assessed that all banks in the review would have sufficient capital to survive. The results will determine how much capital banks have to hold over the next 12 months, with most of the largest banks expected to see capital requirements fall, freeing up capital for dividends or share buybacks. However, the review excludes mid-tier and smaller banks.

Meanwhile, banks in the UK are expecting to see profits squeezed despite rates continuing to rise. Banks’ net interest margins have risen as the difference between rates on loans and on deposits has widened. This has contributed to recent outperformance of bank shares. However, banks are having to offer higher rates to attract retail deposits and many banks have already indicated they expect net interest margins to decline this year.

MARKETS: GLOBAL EQUITIES SHRUG OFF CONCERNS OF RECESSION

Global developed equity markets defied rising interest rates and predictions of recession to produce strong returns in the first half of the year. After significant setbacks in 2022, US technology stocks have led a very strong rally as interest in artificial intelligence spurred stocks like Nvidia, Microsoft and Alphabet to huge gains. Japanese stocks have also risen substantially as relatively strong economic growth and low inflation have spurred a broad rally. After a strong start to the year, European equities have faded as higher inflation and recession in Germany had an negative effect. However, European stocks are up more than 10%. UK equities have also gained but are significantly lagging other markets as high inflation and weak growth have sapped investor enthusiasm.

Fixed income assets have struggled in the first half the year as rising rates have eroded bond values. Higher rates have caused sterling to appreciate and this means UK-based investors have not experienced the full benefit of equity market gains so far this year.