Monthly Market Update: 2023 will not be like 2022

Thu 17 Nov 2022

The British Autumn drama entered its third act, and the worst seems behind us. The UK has what may pass for an equivalent to the Euro-crisis technocratic governments in Italy and Greece. That particular playbook would, at this point, see market volatility ebb. Indeed the UK’s 30y bond is now almost at the same place as the day before the disastrous mini-budget and the Pound is back where it was at the beginning of September versus the Euro. Bar any other surprises during the Autumn budget, we would not expect the UK to be singled out by bond vigilantes again in the next few weeks.  Markets, and press headlines, seem to be finally moving on.

Having said that, the play usually hides an unsurprising fourth act. In Italy and Greece, the ‘difficult decisions’ caused the incumbent economic and political elite to collapse. It takes an enormous effort and political skill to maintain credibility with voters when one opts to satisfy ‘bond vigilantes’ and hedge funds to the detriment of one’s electorate. Very few political leaders, if any, have managed to pass the ‘market-voter test’. It could be that Mr Sunak’s story is different. After all, he was an active politician, not an outsider, and he is backed by a strong one-party majority, unlike other technocrats backed by shaky multi-party coalitions. Most importantly, Britain is making ‘difficult decisions’ for itself, however much under duress, unlike other countries where those decisions were visibly imposed by external organisations, like the EU and the IMF. Nevertheless, this is a story for the near future, but not for right now. Markets, and press headlines, seem to be finally moving on.

Which should turn our attention to global stocks. The Fed’s decision to remain hawkish at a point where markets had started discounting a ‘dovish pivot’ took many by surprise and the beginning of November saw global equities losing their –big- October gains.

While we have been in the ‘pivot camp’ for some time, we haven’t seen evidence to justify the narrative playing out right now. The month saw the most aggressive Quantitative Tightening since last May. Fed officials have been persistently hawkish and bond futures continue to price in more than five rate hikes by mid-December. There is simply no signal from the Fed that they are willing to even consider easing up on their inflation fight right now.

Looking at things sanguinely, we are somewhat disappointed at the lack of acknowledgement of the risk build-up in the economy and the bond market, due to the Fed’s hawkishness. The US central bank continues to focus on inflation, persistently sidelining its role as the lender of the last resort and the world’s de facto central bank. On the one hand it may preserve its reputation as a staunch inflation fighter. On the other hand, ignoring warning shots in the UK and Japanese fixed income markets and quickly rising global yields and spreads, is risking a financial accident. 

Broadly, we think the Fed could  ‘pivot’ to an easier regime by February. Three things will happen by then.

-More stress in fixed income markets (likely)
-The economic downturn play out (more likely)
-There will be fewer hawks voting for monetary policy after January (most likely)

We are more optimistic for 2023 than we were for 2022. Having said that, investors should tread carefully until they have actual confirmation that the Fed has changed its stance. We would not be surprised if we saw more retrenchments and volatility in the near future.

George Lagarias – Chief Economist