Episode Details

The ECB raised rates last week to 2.5% despite slowing growth citing rising inflation as the key driver for the decision. Lower growth and higher inflation smells of deflation, the worst possible economic outcome!

Energy prices have risen 14.3% in the Eurozone this year pushing the CPI to 3.3% for August. This is lower than the 3.4% headline number print in the US putting intense pressure and focus on the Fed for this Wednesday’s FOMC decision on rates.

Wil they? Won’t they – Investors have been chasing their tails for the last month trying to forecast direction of travel on US rates. Our take is that the decline in growth overall despite rising inflation, may be the economic fundamentals to anchor a no change decision. In the meantime, the political consideration (which will of course not be enunciated in Fed personnel speeches)  is that so close to the mid-terms, an increase could be construed as partisan. Warsh is no wall flower but equally it makes little sense to raise the Administration’s ire so early in his tenure.

But to make that policy decision of no change, the committee will have to consider the likely downside to waiting. 

1. GDP growth has slowed significantly from Q1 and is showing no signs of recovery.

2. Inflation is certainly on the up but the Fed can view this like us, as a geo-political ploy that may begin to unravel post mid-terms.

3. Unemployment is steady at near full-employment but, setting the latest, print aside, momentum is not positive.

Waiting to raise in December, assuming they and us are wring about energy prices, will do little to harm the economy short term whilst maintaining the impression of political neutrality up until the mid-terms.

Unfortunately bond markets are unlikely to take a no change well. They have been trying to force the Fed’s hands with a protracted bond sell-off for a month already.  

The treasury’s light hearted attempt at creating liquidity through bond purchases has resulted in further angst. US 30 year yields finished the week at 30 year highs, the UK treasury paid the highest coupons on bond sales last week since 1988 and German 10 year bunds are at 2009 GFC levels.

The equity market has faired relatively well through this bout of worry. However, with $46bn of cash flowing into money market funds in the last few days, risk assets are on the verge of a short-term ‘crack’.

In the meantime, AI appears to be slowing for no human! Former Anthropic employees are suggesting that the current pace of AI development is likely to lead to the end of humanity within 10 years! A wholly negative outcome for risk assets! 

 Oil prices have surged through $100 per barrel as the Houthis (Iranian proxies) have damaged the Saudi overland pipeline and taken control of a strategic port. Expect these disruptions to continue all the way to the mid-terms with full intent to keep inflation front and centre for the US electorate.

In terms of asset allocation, we’re in defensive mode. US remains the best of the rest with our equal weight S&P500 Index at the highest weight at 10% of the portfolio. Consumer staples going from 4% to 5%, energy from 3% to 5% and utilities from 4% to 5% and materials to 4% with over exposure to Gold. 

Taking profits from Financials, Aerospace, Healthcare and Crypto. All high volatility, recently strong performing sectors.

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