Economy

We are getting closer to the point where the Federal Reserve has done enough to bring down inflation next year. Putting behind its past mistakes of creating too much money and buying too many bonds, it now acknowledges it kept rates too low for too long. It has raised short rates to 3-3.25 per cent and signalled they will be nearer 4.5 per cent by the year end. It has started a large bond sales programme to help drive up the interest rate on longer-term borrowings. The danger now is it lifts rates too high for too long, which would turn the coming downturn into a recession. The European Central Bank is further behind in raising short rates and is not wanting to sell any of the big stock of bonds it owns into the market. Inflation is higher in Europe than the US and will need more action to get it down. The Bank of England started raising earlier than the Fed or ECB and has taken long rates higher, but lies between the two currently on short rates. China is able to gently cut her rates and has relatively low inflation, while Japan keeps its rates at zero as at last it sees some inflation emerging.Most bond and share markets and portfolios have fallen in 2022 as rates have been increased sharply from ultra low levels to belatedly combat the price rises. Longer bonds have suffered badly, as they always fall away more quickly when interest rates rise. If rates go from 1 to 2 per cent then a bond offering 1 per cent with no repayment date will halve in value, so the £1 fixed income on £100 of bond becomes a 2 per cent income on the reduced £50 value. A one-year bond paying 1 per cent will fall by around 1 per cent so on redemption you get £1 of capital gain to add to your £1 of income. Now that you can get a much better income yield and there have been such big falls, I am starting to put some of the cash into longer-term US bonds. Despite having substantial cash instead of longer bonds this year the overall FT fund has also fallen as share values have retreated. The biggest holding is in world shares, seeking maximum diversification as a bit of defence. The areas which did so well in previous years as the digital and green revolutions powered ahead have fallen on hard times this year, so it was right to have reduced exposures to them significantly ahead of the sell-off. A Nasdaq ETF used to be the largest holding, which I cut back. It would have been better to have sold all the specialist digital as well.So the main question investors need to ask is how long and deep will the downturn be? It is only just taking shape. In the US we see the digital giants reporting more difficulty in sustaining sales growth and margins. Advertising revenue is harder to come by. Mortgages at rates of 6 or 7 per cent have led to a collapse in homebuying and a need among housebuilders to cut back and sell stock. We expect more earnings downgrades and tougher trading conditions for many businesses into next year as the severe monetary tightening takes effect. The US benefits from its strong domestic energy position with a surplus of natural gas.The world’s second-largest economy, China, is not offering much support to global growth in the way it used to. Dogged by rolling lockdowns of cities and regions to pursue its net zero policy, output is not growing at anything like pre-Covid rates. President Xi Jinping has assumed more powers and put many more of his supporters into key positions. He has determined on a more communist policy, with more activity routed through nationalised industries. He continues his crackdown on some parts of the free enterprise sector, and seeks to remove excesses from the property world which had accounted for substantial increases in output.China’s poor record on human rights, its growing intervention in prices, profits and activity by business, and the wish to put zero Covid ahead of recovery does not make it an inviting prospect for western investors, though it is due a bounce on any diminution of lockdowns with monetary stimulus.The world’s third-largest economy, Japan, is at last getting some inflation from world energy prices, but with core inflation still below 2 per cent it continues with zero interest rates and sluggish growth. The very weak yen is beginning to worry the authorities.

The EU is suffering badly from the war on its doorstep and from the energy shortages brought on by the need to end dependence on Russian gas and oil. There will be recessions in various European countries over the next five quarters, made worse if the ECB overtightens. The EU is finding it difficult to agree Europe-wide policies on sharing energy resources and subsidising those in need. Germany has set out a €200bn offset package to help German industry and consumers — measures resented by other states that cannot afford something similar.It is still not possible for markets to look forward to a shallow and short downturn followed by a good recovery. No advanced country central bank is yet ready to pause its actions to curb inflation and none will guide us to expect falling or even stable rates any time soon. Company margins have reached very high levels, and are likely to come down as the cost of living crunch makes consumers more cautious. It is always painful coming out of fast inflation, and there remains the danger of central banks overcorrecting for past errors. The brutal Ukraine war continues, but some of the worst supply shortages such as microprocessors are easing. Commodity prices are generally weakening as people contemplate lower demand in a downturn, though Opec is cutting back on oil supply and Russia is threatening part of the grain trade again. It is not yet time to increase the share portion of the fund and not yet easy to divine which sectors and areas will respond best to the recovery when it comes. The cash is destined for more bonds as we approach a pause in rate rises.Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing. [email protected]

The Redwood Fund — November 1 2022NameWeightiShares Core MSCI WLD GBPH D20.71%British Pound19.89%iShares USD Short Dur USD D12.08%iSHARES USD TIPS 0-5 GBP-H D5.73%X S&P 500 GBP5.67%iShares USD Treasury 7-10Y4.94%Lyxor Core UK Government INF4.17%Vang FTSE250 GBPD4.02%X MSCI Taiwan3.56%L&G All St In Lnk Gilt IN-IA3.19%Lyxor Core MSCI Japan DR-MHG3%SPDR 0-5 EM USD Government2.26%iShares Global Clean Energy2.12%L&G Cyber Security UCITS ETF2.04%L&G Robo Global Robotics & Aut1.88%iShares Core EM IMI ACC1.78%L&G Hydrogen Economy ETF1.53%X MSCI Korea1.42%Source: Charles Stanley More

Katherine Tai, the Biden administration’s most senior trade official, has called on the EU to introduce subsidies as she offered a trenchant defence of the US’s bumper green energy package that critics say unfairly supports its own manufacturers. The White House’s Inflation Reduction Act, a $369bn flagship package to spur investment in green technologies, was signed into law in August, offering subsidies and tax credits for US-manufactured products ranging from solar panels to electric vehicles. Tai, the US trade representative, said in an interview with the Financial Times following a meeting with European ministers in Prague that she was “extremely proud of the investments [in a clean future] that we have made as the Biden administration”. However, Tai’s counterparts in the EU and other US allies, including South Korea and Japan, have hit out at the act, claiming it contravenes World Trade Organization rules and risks robbing them of investment in green technologies. The combination of the IRA and higher European energy prices is leading some manufacturers to consider shifting their operations from the EU to the US, exacerbating transatlantic trade tensions at a time of global geopolitical uncertainty. Tai countered criticism of the act by calling on the EU to step up support for its manufacturers and reduce reliance on China for strategically important products in the process. Alongside the IRA, Washington passed a $52bn Chips and Science Act over the summer, aimed at reducing the US’s reliance on imports of crucial goods such as semiconductor chips by bolstering domestic investment. The EU has announced similar measures, which Tai suggested Brussels should build on to develop a new industrial policy alongside the US to counter the threat China posed. “Our vision is for an industrial policy that isn’t just about us, but is about complementing the work with our friends and allies to allow us to together build a resiliency and to wean us off some dependencies and concentrations that have proven to be so economically harmful over the last couple of years,” Tai said. She added: “Avoiding a race to the bottom on subsidies will help us to deconflict so that we’re not each reinventing the wheel on our own and to look at our comparative strengths so that we can build this resilience together.”Japan and South Korea could be included in this anti-China partnership, Tai said. Her remarks are unlikely to smooth relations with European officials, who will next week meet their US counterparts in a taskforce set up to broker a deal over the IRA. Josef Sikela, the Czech economy minister chairing Monday’s meeting of EU ministers in Prague, said the act was “unacceptable” and the EU wanted the same treatment as Canada and Mexico, whose companies are treated as American for the purposes of a $7,500 consumer discount on electric vehicles. Tai refused to say if that would be possible. However, she claimed there was “political will and commitment from the highest levels of our government” to reach a deal.“I have every confidence that we will be able to work towards a resolution.” However, it remains unclear what concessions could be made to the EU and other allies without involving Congress, which is unlikely to reopen the act.EU officials recognise that President Joe Biden wants to rebuild his country’s industrial base — a policy seen as essential in shoring up the Democrat vote.But they believe Washington must offer concessions to EU companies. A joint meeting of the Trade and Technology Council, a transatlantic forum set up to align regulations, on December 5 is seen as a deadline for progress, one EU official said.Valdis Dombrovskis, Brussels’s trade commissioner, on Monday said the IRA “may discriminate against EU automotive, renewables, battery and energy-intensive industries”. He said he favoured a negotiated settlement but could pursue a complaint at the WTO as a last resort.Todd Tucker, a director at the left-leaning Roosevelt Institute think-tank, downplayed the EU’s complaints. “There’s a lot of market share on the table as production shifts away from China,” said Tucker. “Until we have way too many EVs on the market, there’s not really a lot of reason to be complaining about each others’ subsidies.” The EU said Brussels did not want to bring the case to the WTO and risk a trade war when the US’s and the EU’s foreign policy priority is presenting a united front against Russia.Tai said the EU and US had a shared view on “the economic competitive challenge from China”. 

However, Brussels has not joined in on punitive measures aimed at Beijing, such as recent US controls on chip exports, instead preferring to rely on domestic incentives to counter China. German chancellor Olaf Scholz recently pushed for Chinese state-owned shipping conglomerate Cosco to be able to buy a stake in a container terminal in Hamburg.Tai said the administration was “following closely” the developments, but added that policymakers in Berlin were not “naive” about China.“The EU and US have to be very candid with each other, very open and communicative to ensure that we are maximising our co-operation because no single one of us can or should go it alone.” More

The writer is chief economist at UBS Global Wealth ManagementIn the world’s financial markets, US Federal Reserve chair Jay Powell is increasingly cast in the role of playground bully — looming over the prostrate form of the global economy and chanting “hike, hike, hike” with malicious glee. US policy rates are rising relentlessly. However, Powell’s public remarks offer little insight into how he expects higher rates to tame inflation. The omission matters as the current policy tightening will have an impact through an unusual route. That is because today’s price inflation is more a product of profits than wages.Broad-based inflation is normally a labour-cost problem. The rule of thumb is that labour costs are around 70 per cent of the price of a developed economy’s consumer prices. If wage increases are not offset by greater efficiency or reductions in other costs, the consumer will pay a higher price for the labour they are consuming. With normal inflation, central banks would need to create spare capacity in labour markets to push wages lower.Wages have been rising but prices have been rising faster, so real wage growth is catastrophically negative. This is far removed from the 1970s-style wage price spiral; apart from the wage and price control debacle of Richard Nixon’s presidency, US real average earnings rose for much of the decade.The US restaurant and hotel sector helps explain why wage costs have played a limited role in today’s inflation. Since the end of 2019, the average earnings of a worker in this sector have risen just under 20 per cent. But the number of employees has fallen over 5 per cent. Paying fewer people more money means that the sector’s wage bill has risen roughly 13 per cent. The real output of the sector has risen 7 per cent. So US restaurants and hotels are paying fewer people more money to work harder. The rise in wage costs adjusted for productivity since the end of 2019 is somewhere between 5 and 6 per cent. Restaurant and hotel prices have risen 16 per cent.This is the current inflation story. Companies have passed higher costs on to customers. But they have also taken advantage of circumstances to expand profit margins. The broadening of inflation beyond commodity prices is more profit margin expansion than wage cost pressures.How is this happening? Two forces have combined. Despite negative real wages, consumers have carried on consuming. Strong post-pandemic household balance sheets have allowed lower savings and increased borrowing to offset the sorry state of real wages. The resulting resilience in demand has given companies the confidence to raise prices faster than costs.In addition, the power of storytelling has conditioned consumers to accept price rises. Imagine a story about a farmer who takes wheat to the windmill, where it is ground into flour, and then baked into bread. In that fantasy world, a rise in the cost of wheat of say 22 per cent might be used to justify a 15 per cent rise in the price of bread.

An economist might splutter incoherently over their morning toast, and point out that only 10 to 15 per cent of the price of bread is attributable to the cost of wheat — the cost of food in developed economies is not about food at all; it is labour costs. But the narrative might seem plausible to many a consumer.And consumers seem to be buying stories that seem to justify price increases, but which really serve as cover for profit margin expansion. Indeed, the soundbite economics of the Twitter era helps this process along. This unconventional inflation means higher unemployment and lower wages are not the only possible cure for it. Policy has more routes to lower inflation if the cause is about profits. Of course, higher unemployment and lower wages would weaken demand and squeeze profit margins. But any softening of demand — for instance through slowing the leverage of household balance sheets — would also affect pricing power. The slowing demand for consumer durable goods this year turned the fastest ever inflation in prices for those products into the most dramatic deflation since data started being collected on them in the 1950s.So the prices that drove the early 2021 inflation story were transitory after all. By understanding that, the narrative used to justify today’s higher prices could also be attacked. Social media memes work both ways; a narrative of “rip-off Britain” and intense media focus in the UK in 2010 may have damped inflation at that time. Ending Fed chair Powell’s sphinx-like silence on what higher rates are supposed to achieve could help turn around the inflation story. More

At a shopping mall near Clackamas, Oregon, a new recruitment centre is trying to sign up workers for a Warren Buffett-owned company that makes jet engine parts. Two years after Precision Castparts laid off 40 per cent of its workers in response to a coronavirus pandemic-induced collapse in aeroplane demand, the company is back in hiring mode. It is making too few castings and forgings for engine makers, which in turn are struggling to satisfy the demands of the world’s biggest plane makers, Airbus and Boeing. A lack of workers at the Berkshire Hathaway subsidiary is but one factor fuelling a global shortage of engines and the high-precision parts needed to make them, which is hampering the recovery of the global aviation industry just as passengers flock back to air travel. “When the business downturns, the easiest call to make is to cut heads with no thought at all as to what I’m losing,” said Dave Coates, a former human resources manager at Precision Castparts who retired last year.The attempt to attract recruits would not improve production any time soon, Coates added, given that it takes up to three years for production line workers to hone their skills. Persistent supply chain disruptions were on display during recent third-quarter earnings updates from aerospace and defence companies, which were described as “a ride on the struggle bus” by Rob Spingarn, analyst at Melius Research. Although shortages of parts and workers had “modestly improved”, Spingarn wrote in a note to clients, “it still seems that most companies are playing whack-a-mole”, leading to delayed sales and higher costs. Boeing’s top executives told investors last week that a paucity of engines was the main thing preventing it from delivering much more than 20 of its 737 Max planes each month — even though airlines are clamouring for them. The jet maker said production would speed up late next year and promised more details at Wednesday’s investor conference, which is seen as a test of the company’s ability to restore credibility with Wall Street in the wake of two fatal Max crashes.“I am confident the industry will step up,” chief executive David Calhoun said last week. “But it will take more time than I probably had hoped.”The situation at Airbus has improved since the summer, when chief executive Guillaume Faury said the company still had 26 “gliders”, newly built planes without engines. Now the number sits at fewer than 10. But Faury said he expected the supply chain bottlenecks, which forced Airbus to scale back plans to increase production of the A320 family, to last well into next year.Deliveries of Leap engines made by CFM International, a joint venture between France’s Safran and the US’s GE Aviation, are still behind schedule, executives said last month. The Leap engine powers Boeing’s 737 Max and is also an option for Airbus’s A320neo jets. Shipments rose to 347 in the third quarter, up 54 per cent on the previous three-month period but still lower than originally planned.CFM had not yet made up for delays and was still “struggling on castings, especially in the US”, said Safran’s chief executive Olivier Andriès.Castings are made by pouring molten metal into moulds to form parts such as engine blades and “structural” elements that hold an engine together. The process is difficult to master. Even experienced workers can be forced to throw away 5 per cent of a production run, and for newer products, the proportion can be as much as half. Indy Rattu, vice-president for European operations at UK-based Doncasters, said the high levels of qualification and certification needed in the industry were a challenge. The high-precision manufacturer, which traces its roots to the city of Sheffield in 1778, makes blades and structural castings for engine makers. But it has found that some of its suppliers either did not survive the pandemic or are struggling to source materials and parts. Although the number of suppliers that folded was relatively small, Rattu said that “many are qualified for very specific products, so when they disappear . . . it makes the job of finding an alternative extremely challenging”.On an earnings call last week, Greg Hayes, chief executive of Raytheon, which owns engine maker Pratt & Whitney, said the lack of castings stemmed from labour shortages.Ron Epstein, analyst at Bank of America, said: “Aerospace has had, on average, an older workforce. If you accelerated your retirement because of Covid, a lot of those folks are just gone. And it’s highly skilled labour. You can’t just take someone off the street and have someone do this.”Companies are also reluctant to start making castings and forgings because the list of potential customers is limited, added Epstein, unlike, for instance, the auto industry. The next six months will be critical as the industry navigates the recovery at a time of persistently high inflation.

A push by Boeing and Airbus to boost production will continue to put strain on the inherently tricky relationship with their suppliers. There is always “tension” between the two, said Nick Cunningham, analyst at Agency Partners in London. “The airframers can probably often add more capacity by hiring some more assembly labour and working more shifts, but the suppliers may need to add hard tooling and skilled people and don’t want to invest big dollars to meet a brief peak in demand.”Frank Perryman, chief executive of a privately held titanium mill in Pittsburgh that sells metal products to parts makers, said aerospace suppliers had reduced headcount and needed to see more orders before stepping up recruitment. “You can’t slow the world down and expect it to speed back overnight.” More

The Federal Reserve is set to raise its benchmark policy rate by 0.75 percentage points on Wednesday for the fourth time in a row, as it continues its long-running battle to bring down persistently high US inflation.The Federal Open Market Committee is expected to lift the federal funds rate to a new target range of 3.75 per cent to 4 per cent following its two-day meeting, intensifying its grip on an economy that is proving more resilient than expected in the face of aggressive monetary tightening.The Fed’s decision to press ahead with its supersized rate rises comes amid mounting evidence that the most acute inflation problem in decades is not improving. This is despite signs that consumer demand is starting to cool and the housing market has slowed significantly under the weight of spiralling mortgage rates, which last week rose above 7 per cent.Data released since the September gathering have shown consumer price growth accelerating once again across a broad array of goods and services, suggesting underlying inflationary pressures are becoming more entrenched. The labour market also remains very tight, with strong wage growth and resurgent job openings.Wednesday’s decision will move the federal funds rate further into “restrictive” territory, meaning it will more forcefully stifle economic activity.Given how far the Fed has already lifted rates — from near-zero as recently as March — top officials and economists are having increasingly urgent discussions about when the US central bank should slow the pace of its rate rises, particularly since changes to monetary policy take time to filter through the economy.

The Fed first introduced the notion of slowing down “at some point” back in July, and forecasts published at the September meeting suggest support for such a move in December. At September’s meeting, most officials projected the fed funds rate reaching 4.4 per cent by the end of the year, indicating a step down to a half-point rate rise next month.Economists are concerned that by prolonging its aggressive tightening programme, the Fed risks triggering a more pronounced economic downturn than is necessary, as well as instability in financial markets. Some Fed watchers warn that recent flashpoints in the UK government bond market, which required the Bank of England to step in, offer a cautionary tale.Democratic lawmakers have also called on the Fed to back off of its aggressive approach.However Fed chair Jay Powell will be under pressure to reassure economists and investors that slowing the pace of rate rises does not mean a reduced commitment to stamping out price pressures. To that end, many economists expect the Fed to back rate rises that exceed the 4.6 per cent peak level planned in September. A benchmark policy rate of at least 5 per cent is now expected to be required to tame inflation. More

OTTAWA (Reuters) -The Bank of Canada has not ruled out another oversized interest rate hike to fight sky-high inflation, governor Tiff Macklem said on Tuesday, acknowledging Canadians feel “ripped off” by fast rising prices.Macklem, answering questions in the Senate’s banking, trade and economy committee, said that while the central bank is starting to see signs rate increases are slowing the economy, it is still in excess demand.”Looking forward, we have indicated that we think interest rates need to go up and maybe that’s another bigger-than-normal step, or maybe we can go down to more normal steps,” Macklem said. “But we still think we have more to go.”The Bank of Canada surprised markets with a smaller-than-expected 50-basis point increase last week, lifting the policy rate to 3.75%. It also forecast the economy would stall over the next three quarters. Inflation, meanwhile, has eased to 6.9% from a peak of 8.1%, but it is still far above the central bank’s 2% target and underlying price pressures remain broad-based.”Our mandate is price stability, we’re a long way from that mandate,” said Macklem. “It’s been a long time since we had high inflation and we’re rediscovering that it corrodes the social fabric,” he added. “It makes people angry. People feel ripped off. And that’s one of the big problems with inflation and it’s an important reason why we got to get it back down.” Earlier he reiterated the Bank of Canada would need still higher rates to fight stubborn inflation. “How much further (rates rise) will depend on how monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding to this tightening cycle,” Macklem said.”The effects of higher rates will take time to spread through the economy. … There are no easy outs to restoring price stability.” More

“If achievement of our 2% inflation target comes into sight, making yield curve control more flexible could become an option,” Kuroda told parliament.But he added that for the time being, the central bank must maintain ultra-low interest rates and keep downward pressure on the entire yield curve to support the economy. More

SEOUL (Reuters) -South Korea’s annual consumer inflation in October ticked up from September against market expectations for no change, led by lagging effects of earlier global raw materials prices, government data showed on Wednesday.Both the finance ministry and the central bank played down the accelerated pace of prices growth in separate statements and affirmed their previous projections that inflation would stay elevated for some time.The consumer price index (CPI) rose 5.7% in October from a year earlier, according to the Statistics Korea data. The rate had slowed in September to 5.6% from 5.7% in August, compared with a near 24-year high of 6.3% in July.The median forecast in a Reuters survey of economists was for the annual CPI growth to be 5.6% in October, although five of the 11 economists polled predicted higher rates.”This is in line with our view that inflation has passed its peak, and I think the Bank of Korea will pay more attention to credit market conditions and the U.S. policy prospects,” said Park Sang-hyun, economist at HI Investment & Securities.The country’s central bank, which has raised the policy interest rate by a combined 250 basis points since the middle of last year from record-low 0.5%, next meets on Nov. 24 to set the rate. The Bank of Korea said in a statement issued after an internal meeting of officials that it expected inflation would stay at the 5% level through the first quarter of next year, though the level of uncertainty was high.The CPI rose 0.3% in October on a monthly basis, the same rate as in September and higher than a 0.2% gain seen in the survey.Core inflation, which strips volatile foods and energy prices, ticked up to 4.2% in October on an annual basis from 4.1% in September to mark the fastest since December 2008. More