Can you feel the pain? Are the pips squeaking enough yet?

 

Whatever our own individual circumstances, we are all presented with economic choices about paying the bills. Elasticity of demand: do I need to use the car as much? Or in the winter, how long do we keep the heating off and put on another layer instead? Product substitution: branded groceries from Waitrose still? Or will Aldi half a mile further on do instead. As for the basics, washing-up liquid and loo paper: Tesco? Or B&M? Discretionary items: is the post-Covid family holiday abroad a luxury or a necessity? And if we go, will it be a la carte all-inclusive or self-catering? At home, we all like a night out, but how often and on what budget?

 

Commuters’ season ticket prices are regulated on a RPI+1 basis, and are set in July for the following year. Already a major financial commitment for some, the cost in 2023 will be eye-watering for many. Can you afford to go to work? Can you afford not to? Or, like the train drivers, do you think about withdrawing your labour? Debt management: will you be able to afford the monthly mortgage payments as interest rates rise? Cashless is the new norm, but how much is that credit card costing you every time you idly swipe the terminal? APRs over 20% are very expensive. Savings: what is left to set aside for a rainy day? Or is this the rainy day? Wittingly or not, we are all in practice applying theory familiar to any ‘O’ Level Economics student.

 

While protesting unconvincingly that at heart he’s a natural low-taxation Chancellor, Rishi Sunak is cheerfully bleeding your monthly pay packet with his new swingeing National Insurance levy. It might be badged a hypothecated tax and called the NHS Levy, but in the melting pot of the Treasury cash pool the annualised £12bn receipts are already dwarfed by the £20+bn of additional annualised interest payments on the index linked element of the government’s debt thanks to inflation approaching five times the Bank of England’s target rate of 2%). Also, as of April, the energy price cap regime sees your quarterly electricity and gas bills rocket off the scale on your not-so smart meter and with another substantial hike slated for October; and as diesel flirts with two quid a litre you now wince audibly in trepidation every time you drive your combustion-engine vehicle on to a garage forecourt to fill up the tank (of which a fixed 52.95p of every litre that goes in is duty, and then there’s 20% VAT on top). As for domestic heating oil, it is now a major financial decision, often and alarmingly measured no longer in hundreds but thousands of pounds, as to whether to top up now or risk leaving it until the autumn.

 

As the steam comes out of the economy and the OECD joins the queue of star-gazers forecasting zero growth next year in the UK, but we’re faced with rampant inflation, increasing industrial unrest and with political dislocation, for those of us of a certain age, it has all the hallmarks of the early 1970s. Glam Rock, flares and stacks, power cuts, Austin Allegros and the three-day week, the only real glamour is through rose-tinted spectacles. 

Putin’s plan: everybody else hurts, one way or another 

We need to look at the bigger picture to make sense of all this.

 

The Russo-Ukrainian war has been going more than 100 days, already nearly a month longer than the Falklands conflict of exactly 40 years ago. There is no end in sight. But the knock-on effects are both pernicious and perceptible.

 

You may remember, back in the dark, late-winter days of March, we introduced one of these musings early in the conflict with the words: “welcome to World War Three”. The bullets, bombs, mortars and missiles flying back and forth might still be geographically confined within the borders of Ukraine (with both sides stretching the boundaries: Ukrainians have targeted installations within Russia, while at the same time Russian military aircraft have regularly tested and transgressed NATO airspace) but make no mistake about the extent to which this is a simmering conflict of global proportions. Vested interests; new geopolitical tensions where no stress was visible before; new alliances being fomented elsewhere, some surprising others not so; the significant economic consequences globally and still compounded by China’s covid response, albeit now relaxing a little: the rapid evolution in three months is palpable. 

Economic warfare is an integral part of Putin’s armoury 

On the economic front, the two main areas of focus remain food and energy. Both are creating substantial inflationary pressures across the economic spectrum through the combination of western sanctions and both sectors being weaponised in return by Putin in retaliatory economic warfare with NATO and political leverage with his allies. Other commodities, in which Russia and Ukraine account for significant global market shares or are significant exporters, include nickel, copper, iron and palladium (and potash from Belarus), but the basics, that is to say food and fuel, the economic bedrocks of society, are the principal all-pervading battlegrounds.  

Wheat: leveraging misery from a global food staple

In a normal average year, Russia accounts for around 19.5% of global wheat exports (in 2020 the monetary value of those Russian exports was $10.5 billion) and is by some way the biggest exporter in the world; Ukraine’s share is 9%, ranking 5th, behind the US and Canada and narrowly smaller than France.

 

At the end of May, the Russian ministry of agriculture forecast that the 2022 season would see Russia produce 130 million tons of grain, including 87 million tons of wheat, an all-time record (possibly as high as 90 million tons if the weather is perfect during ripening and harvest time). India, Kenya, and the north American mid-west wheat belts are all subject to bad growing conditions this year thanks to drought and/or heat-waves, and India has put a ban on grain exports in order to retain enough to feed its people; the global supply-side is already very tight and the international price has more than doubled in a year. If in the developed world we are preoccupied with the affordability of basic foodstuffs, in many developing nations the simple and singular obsession is accessibility. Russia has blockaded the Black Sea, significantly impeding Ukrainian exports which currently are down by two-thirds year-to-date.

 

Between sanctions and blockades, 30% of the wheat traded globally is subject to disruption. But despite western sanctions, Russian wheat exports are up year-on-year. How can this be? There are many complex political manoeuvrings behind the scenes, but the essential answer is simple: Putin is taking advantage of every chink in the sanctions armour to find open channels, and simultaneously stealing Ukraine’s former export markets and in the process helping eviscerate its economy which is expected nearly to halve in size this year. Where he has lost sales to countries obeying the sanctions, he has made up the difference and more by selling increased quantities principally to Turkey (a NATO member), Iran and Egypt (the world’s biggest importer). It is not clear whether those countries may also be acting effectively as fences for ‘blood wheat’ and selling any surplus on to third parties. Assuming they are not laundering grain, nevertheless at the political level and using wheat as a lever Putin’s dealing with them ensures he retains allies and sympathetic influences within organisations such as NATO and the United Nations. Leveraging misery and the threat of famine in East and North Africa and parts of the Indian sub-continent, Putin is ensuring that his export volumes rise against an escalating price, placing those countries in his debt and all the while seeing that his own people have more than enough food staples for domestic consumption. There will be no queues let alone food riots for bread in Moscow, St Petersburg, Murmansk or Vladivostok, or anywhere else in Mother Russia, not if he can help it. 

Fuel: cynically and calculatedly exploiting capacity shortages

Putin’s tactics in the energy sector are similar: find the weak spots in the sanctions regime and exploit them ruthlessly. We have discussed on many occasions what is happening in both the crude oil and gas markets. The sanctions net in oil is gradually tightening as the EU joins the US and the UK, albeit Brussels only promising no more imports by the end of the year and with dispensations for land-locked Hungary whose energy sector is almost entirely reliant on Russian piped oil (on the same arterial pipe shared with the Czech Republic and Slovakia).

 

Beyond that, countries such as India and China are willingly mopping up any Russian surpluses which are being offered at significant discounts, maintaining an important source of immediate currency and cash flow to Moscow to fund the war programme, all settled in roubles as demanded. But as the noose tightens, OPEC continues to refuse to play along with Joe Biden and open its taps to make up for the potential shortfall. Global inventories are running very low despite this being the seasonally slack period for consumption. The price of crude is slowly but surely hardening with Brent approaching $123 at the time of writing on 10 June, against $99.7 on 10 May, and close to its most recent intra-day high above $130 on March 8th in the immediate aftermath of the US/UK embargo being announced against Moscow.

 

Gas, as we have discussed before, is more complex than oil, particularly in Europe because of heavy reliance on Russia and the directional, point-to-point nature of delivery via a web of overland pipes and through Nord Steam 1 under the Baltic. As Europe works out how to wean itself off Russian dependence and how much economic pain it is willing to endure until US supplies of LNG can make their way across the Atlantic under the new 8-year Biden-von der Leyen gas pact (facing the immediate setback caused by a major fire closing the Freeport terminal in Texas which accounts for a fifth of US production for at least three weeks), getting in his own retaliation Putin continues to turn the screw on supplies to the West. He had already cut off Poland and Bulgaria; now through Gazprom he has also curtailed supplies to Holland and those customers in Denmark, Germany and Finland who refuse to settle contracts in roubles. All of which has pushed wholesale prices this week to levels not seen since before the Global Financial Crisis and three times higher than a year ago. 

No relief at the pumps 

But it is not just primary, upstream products such as crude oil and natural gas. It is also affecting downstream products such as gasoline/petroleum and diesel. Following the post-embargo panic in March when crude prices spiked briefly in excess of $130 before settling down for some weeks at around $105, you might have been expecting some relief in the retail price at the pumps. Not a bit of it. UK pump prices remained strong and rose consistently to today’s record levels (despite Sunak taking 5p off fuel duty in the Budget).

 

Russia supplies around 18% of all the UK’s diesel consumption; as the embargo takes hold not only here but elsewhere, and thanks to a dearth of new investment in the fallow years following the prolonged collapse in global oil prices in 2014 and exacerbated in 2020 by the pandemic (in the spring of 2020 the price briefly went negative and people were literally paying to get rid of the stuff: remember that? How time flies!), there is insufficient spare refining capacity fully to make up the shortfall. Global wholesale prices of refined products (traded in Dollars), including diesel, continued to rise; add to which the escalating costs of distribution and labour and it is not difficult to see the pump pain we referred to in our opening paragraphs.

 

In the UK, the position is exacerbated by the strength of the US dollar since the war began as investors are drawn towards it as a natural safe-haven currency thanks to a hawkish Federal Reserve and relative to Europe, the US economy being less directly affected by the war (the trade-weighted dollar index against a broad basket of currencies is 118 today against 110 a year ago, while since the day of the invasion, sterling has depreciated 8% against the dollar). 

The ECB’s ignominious and inevitable surrender from a hopeless and indefensible position 

It is against this backdrop that bond yields have continued to push higher. Most significant has been the recent behaviour of the German 10 Year government bond: if US yields have been firm with the US 10 Year government bond no longer suffering vertigo and frightened of 3%, German yields have been rising determinedly. Only four months ago, Germany’s 10 Year government bond yield was negative; today it is nudging 1.5% without the European Central Bank (ECB) yet having changed the deposit rate.

 

However, the markets have successfully forced Christine Lagarde to concede that her ‘I’m-right-and-you’re-all-wrong’ stance on the real enemy being deflation has simply run out of credibility. She is the last major central banker to be smoked out of her bunker about raising interest rates: her stated intention, as of this week’s policy meeting, is that next month the ECB will raise its deposit rate from minus 0.25% (where it has been without a break since December 2015) to zero, and then having suddenly developed a taste for it, will raise it again to plus 0.25% in September. We will see what happens after that: one step at a time.

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. 

The value of active minds – independent thinking

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Fund specific risks

The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.

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This document is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. Past performance is no guide to the future. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the authors at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. For definitions please see the glossary at jupiteram.com. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Company examples are for illustrative purposes only and not a recommendation to buy or sell. Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority. No part of this document may be reproduced in any manner without the prior permission of JUTM or JAM. 29156