Market Update 30th May 2023

Public laundry

As exercises in can-kicking go, this one has been pretty routine. Subject to what should be the formality of passing Congress (and the commentator’s curse), the warring parties in the United States have agreed to raise what they call ‘the debt ceiling’. It was always going to happen, but it has taken up an awful lot of column inches over the past couple of weeks. The proposed new agreement to limit the amount that the US government can borrow lasts until the start of 2025: which means that at the end of next year we will all have to go through the whole charade again.

The short-term debt ceiling wranglings spotlight bigger issues. The United States government spends more than it earns. A lot more. Old habits, as we know, have a natural longevity. We have argued until our faces turned a brighter shade of periwinkle that the size of government debts matters very little when the cost of servicing it (the interest rate) is next to zero. The problems come, as the Truss-Kwarteng government learned the hard way, when zero interest rates turn into 4%, or so. Then the size of the national debt matters a great deal.

Let us imagine a country which has a national debt of, say, US$31.4 trillion. It is worth just reminding ourselves that trillions have twelve zeros. That is a thousand billion. Our next piece of mental arithmetic is to say that the interest bill on a debt of that size is currently, in very round and rough numbers, US$1tr. Staying in very rough numbers, and simplifying things enormously, that is US$1tr more than if the interest rate was zero. Let us now call this imaginary country ‘The United States of America’.

According to the US Congressional Budget Office, federal revenues for 2022 were $4.9 trillion. Which means, again with a lot of rounding, that around a fifth of the government’s income is going to be tied up with paying the interest on the national debt. I know it is not quite as simple or as dramatic as I am making out, but my point is that public finances are up a gum tree. Nor is anyone ever going to do anything about it with an electoral cycle of about 5 minutes.

Before I am too harsh on the US, I ought to say that it is playing a popular game. Of the countries in the G20, the Netherlands is believed to be operating at close to budget neutral, and Saudi Arabia runs the sole surplus. Everyone else is also spending more than they earn. It is a contest of the least dirty shirts, with no one wanting to go to the laundry.

Last week’s inflation update here in the UK was miserable. Confounding hopes of a sharp drop in the annual rate, the ONS’ latest calculation showed prices rising by an annual 8.7%. More alarmingly, the so-called ‘core’ inflation rate rose sharply to 6.8%. This core rate is supposed to be lower and more stable than the ‘headline’ rate. Indeed. One can sense a degree of panic in Westminster. Messrs Sunak and Hunt are chained to a commitment to have halved inflation by the end of the year. Previously this had looked a safe a bet as saying that Christmas comes on December 25^th. It now looks as if their confidence in Andrew Bailey being able to deliver this is decidedly shaky. And if all else fails, then cheat. Hence we have this morning’s story that the government is favourably disposed towards price caps.

Readers will remember that Mr Bailey, the Governor of the Bank of England, denies any role in the creation of the inflation levels that we have currently. The blame is instead laid at the door of President Putin, covid and me. I hold up my hands here and apologise. As an upcoming early retiree, I am more to blame for 8.7% inflation than Mr Bailey. According to Mr Bailey. Sorry.

We need some better news. UK natural gas prices this morning are 90% lower than last August’s peak, and back to levels we saw in 2018. According to the RAC, the price of petrol of 143.35p per litre is back to where we were in late October 2021. Hurray for that. We have two lingering problems, however. First, the UK’s utterly ridiculous system for pricing wholesale energy costs does not necessarily mean that lower gas prices will mean large falls in bills. Some readers will remember that this wholesale price is set by the marginal producers: the most expensive and least efficient. It is bonkers. The entirely sensible plan to instil some sanity into this regrettably has Kwasi Kwarteng’s name at the bottom (or top) and is thus most unlikely to happen. Secondly, we are beholden to the time lags of the food producers, who, in the aftermath of the invasion of Ukraine, bought forward far too much at prices far too high. This, as we know, is going to take its time to wash through. We have to hope that Mr Bailey resists the urge to keep raising interest rates. The elastic can only stretch so far. The pain of higher mortgages is currently probably just about bearable. One or two more increases though may just take us over a tipping point.

This week takes us into June, and the monthly update to the US non-farm payrolls on Friday. The Federal Reserve has suggested that it is minded not to raise rates again at its next meeting, on June 14^th. Friday’s number will give a strong steer as to whether the Fed really means it.

Jim Wood-Smith – Market Commentator and Head of Climate Transition

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