Recession – Cover story
get inflation down to 3% or so, which should be a satisfactory outcome for markets. Any attempt to reduce this to 2% would be ambitious and might put undue pressure on the economy.” Others are more sceptical. Columnist Stuart Trow argues that monetary policy will have little impact. “People overestimate the power of using monetary policy to fine-tune inflation. It is largely a non-monetary phenomenon anyway. The real reason financial markets are losing their nerve is because interest rates have a much closer correlation to financial markets than they do to inflation. “We have had extreme monetary policy on and off since the financial crisis in 2008, and this is the first time we have been worrying about inflation. And that’s for two reasons: one because global trade contracted sharply, and the other is the onset of Covid gave us fiscal policy measures.“Monetary policy has done nothing to trigger inflation, what it has done is pump up asset prices and when you are threatening to reverse that, you get panic in financial markets,” he adds. Trow warns that monetary tightening could backfire. “At this point, central banks can only do harm because their relevance to consumer prices is almost zero. I am surprised that they have not woken up to that.” Both Trow and Tomlinson believe that de-globalisation – a topic explored on pages 22-24 of this issue – will be a driving factor in keeping price levels elevated. “It feels like we’re in a de-globalising world and it’s difficult to see how that isn’t infla- tionary. It used to be about the lowest cost of production any- where in the world. But now the cost of shipping is going up and the threat of new green taxes are pushing up prices too. Driven by concerns over the security of supply and national se- curity, we are likely to see a shift to more local production which probably will mean higher costs,” Tomlinson says. The problem has been recognised by Andrew Bailey. Speaking at a House of Commons Treasury Select Committee in May, he predicted that UK inflation could hit 10% this year and that the Bank of England would be unable to contain it as it is largely driven by global factors, energy prices, in particular. But being in the firing line of the political blame game over the rising cost of living, Bailey also, somewhat paradoxically, pledged that combating inflation would be his key priority. The tacit acknowledgement being that this might require sending the UK economy into recession.
Stock markets: From growth to value All this should be bad news for stock markets. Nevertheless, while the first three months of 2022 were tough, investors have not exactly stampeded out of shares. Indeed, equity funds in Europe booked some €28bn (£23bn) in inflows. Among developed market stocks, tech heavy incidences such as the S&P500 have been hardest hit with the US index
It feels like we’re in a de- globalising world and it’s difficult to see how that isn’t inflationary.
Richard Tomlinson, Local Pensions Partnership Investments
down more than 15%, year-to-date. But that still only brings it to 2021 levels. When analysed over 30-years, it remains at peak levels.
Other indices, such as the income-heavy FTSE100, have even benefited from investor caution. Year-to-date, the British stock index is up marginally by 0.07% and over a year has risen by 6.7%. This could be an indication that rather than exiting stocks altogether investors appear to be focusing on income instead of growth.
That is despite stock markets being the most bearish of all major asset classes, according to a JP Morgan survey. Stock markets have priced in a 70% probability of recession, com- pared to 50% in investment-grade debt and 30% in high yield, according to an investor note by JP Morgan Strategist Marko Kolanovic. He believes stock markets are overpricing the risk of recession.
Speaking to UK institutional investors it transpires that they are far more cautious, but those who have significant stock market exposure – local government pension schemes and DC Master Trusts, in particular – are not considering reducing it dramatically. At the same time, a strategy re-orientation of sec- tors is certainly on the cards for some. For Cunliffe, of The People’s Pension, responding to short- term market challenges is not in the interest of his scheme, which has a long-term investment outlook.
“The demographic of our members supports a long-term approach, which includes a clear ESG strategy,” he says. “Our
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