Merlin Weekly Macro: The election race is on

And so we’re off, out of the traps: 2.3% inflation, 0.6% growth and Rishi Sunak thinks his Christmases have all come at once. Or was it more that, with an election deadline looming and with inflation coming within a whisper of the Bank’s 2% target (thanks almost entirely to the change in the energy cap in April) and GDP growth one of his five pledges last year that he failed to deliver but which has suddenly revived now, like a drowning man in a fast-flowing river with the latest data he decided to catch hold of any log floating past and hang on for dear life to keep his head above water. He is more than 20pts behind in the polls after all. Time will tell of his fate: will it be Rishi Sunak the PM with a new mandate? Or Rishi Sunk without trace? You decide.

‘Gangbusters’ and a case of exaggerated political licence

But before we discuss the election, let us look at GDP. Last week at Prime Minister’s Questions, Sunak declared: “the Independent Office for National Statistics (ONS) says the economy is going gangbusters, Mr Speaker!”.  Nowhere in the ONS statement is there any mention of the word ‘gangbusters’. We have checked. It is not there, first because it is just not in the dry ONS lexicon to use such florid slang lingo; second the ONS does not make qualitative assessments of the economy; and third, whichever way you look at it, 0.6% growth hardly qualifies for the description of ‘gangbusters’. At 0.6%, what the economy has done is to recover positive momentum after two consecutive quarters of shrinkage. That is undoubtedly good news. But 0.6% is no more than the average of the pre-pandemic quarterly rate. Then we did have fairly consistent, moderate growth. However, thanks to the erosion in productivity and the burgeoning zombie economy with all its inefficiencies, the average rate of real growth in the period following the Global Financial Crisis (GFC) and the advent of quantitative easing was lower than it was before the GFC. As it is, the ONS reckons that compared with 1Q 2023, the economy is 0.2% bigger year-on-year: hardly ‘gangbusters’ but better that it’s positive rather than negative.

The Bank of England prefers the ONS narrative to that of the Prime Minister. With interest rates at 5.25% up from zero in December 2021, and having been at their current level for nine consecutive months, the Bank’s Monetary Policy Committee (MPC) does not want the economy going ‘gangbusters’. Not now.  That would represent failure. Tighter policy was designed to curb consumption and take the steam out of the economy in that period of strong recovery and reopening post the pandemic crash, what was dubbed at the time by investors as the “reflation trade”, subsequently stoked by all the dislocation arising from Putin’s invasion of Ukraine. If the economy were to go ‘gangbusters’ at this stage, it would suggest that consumers are becoming inured, desensitised to the medicine of high rates to curb inflation permanently.

Economic experts flying kites again

Ahead of the MPC meeting in June, policymakers have been flying personal kites again.  Earlier this week it was Deputy Governor Ben Broadbent dropping a strong hint that he expected a quarter percentage point cut in June. Overtaken by events, it is a moot point whether a June cut (the MPC meets on the 20ᵗʰ) is now a possibility at all given it would be two thirds of the way through an election campaign; however independent, the Bank would be open to the charge of helping the Tory narrative of wanting to see lower mortgage rates; any decision by the Bank to move 14 days before polling but after nine months of doing nothing is politically charged. Let’s see how the MPC deals with that.

But back to economists: last week the Bank’s chief economist Huw Pill was also giving his interpretation of the economic tea leaves. Pill remains concerned about the structure of the labour market such that it is still delivering below-average productivity. There are many complex contributing factors. These include the growing number of those of working age who are economically inactive, especially among 50-64 year-olds who have simply absented themselves from the workforce since the pandemic. He worries too about the dysfunction in the NHS and the knock-on effects of creating a significant sub-class of those officially signed off as long-term sick. The zombie economy and productivity issues are largely a direct result of the overcapacity created by 12 years of ultra loose monetary policy: interest rates held close to zero and easy access to cheap credit undermined the Darwinian principle of keeping the economy match fit through the survival of the fittest. It is a painful but necessary discipline to let bad businesses die and allow their capital and human resources to be recycled and better employed elsewhere. The Bank forgot that.

While Pill is in the higher-for-longer camp (in contrast with the International Monetary Fund, the Governor and the deputy Governor), he is still either implying or at least allowing the inference that interest rates will begin falling in the second half of 2024. Where he remains cautious is the inflation outlook. The pressure points are services and wages where idiosyncratic inflation remains uncomfortably above both the average and the target. The debate is the extent to which the Bank should be providing stimulus by relaxing policy while significant elements of the current inflation data remain higher than the 2% target. Remember, it’s not just about hitting the Bank’s mandated target of 2% once, it’s about maintaining stable inflation in line with that target out into the medium term.

The Fed has no autonomy over the right to change policy first

As an aside, while US inflation remains trapped for an 11ᵗʰ month in the narrow band between 3% and 4%, fixed income investors have got over the discombobulation we described recently when reporting how Larry Summers, the former US Treasury Secretary, had said “don’t be surprised if the next move in rates is upwards”. It seems that Summers was not alone. The minutes of the most recent Australian central bank policy meeting released last week indicate committee members seriously considered a rate rise there too, but in the end shied away. Meanwhile, back at the Federal Reserve (Fed), Jay Powell in his own quiet way poured a bucket of cold water over Summers’ prognosis and told markets that a rate rise from here was unlikely. However, you only need look at the continuing lack of direction in US government bond yields to see there are still tensions dividing the various camps about what should or might be happening to future US rates. Even if they do not agree with Summers, a sizeable minority on the Fed’s policy committee still thinks US rates should not be coming down this year at all.

The next round of central bank policy meetings begins in early June. There is no great expectation that the Fed will cut. But even if the Fed does reduce rates at some stage this year, markets have greater expectations that the Bank of England and the European Central Bank will most likely be ahead of it. They seem quite relaxed about that. After all, there is no reason why it must be the Fed which moves first; go back to the inflation hump when it was obviously on the verge of exploding, of the reserve currency central banks it was the Bank of England which began raising rates first, three months before the Fed and seven months before the European Central Bank (ECB). Every economy is different, however much there is a common cyclical element thanks to global commodity prices and so forth. Logic says that at the national level, it should be horses for courses. You let the differential pressure be relieved through the exchange rate.

July 4ᵗʰ: Independence Day. From Keynesian policy? In our dreams

The economy and the election are indivisible, explicitly given the inflation catalyst for firing the starting gun for an election on July 4ᵗʰ.

But there is more to it than simply the economy. Last week, Sunak made what was one of his most considered and impressive speeches (in this modern short attention span, soundbite world the bar was not high). His theme was the strategic security threats confronting us, emphasising the pace of change likely before the end of the decade. He defined security in its broadest terms: defence; economic stability; energy; food; supply chains and so forth. The response was Starmer rolling up his sleeves in the style of Tony Blair with a list of six rather vague pledges from Labour none of which included defence (immigration was added to the original five in acknowledgement that it will be an inescapable factor especially in Red Wall seats). More intriguing behind the scenes was the reported tension between Angela ‘Angry Ange’ Rayner and Rachel Reeves. Their internecine battle ground is Labour’s New Deal. The Deputy Leader is determined to throw raw red meat, and lots of it, to the Unions about employment rights and union law; the Shadow Chancellor is anxious not to frighten the business and employers’ horses. Caught in the crossfire and dithering in the middle is Starmer.

Comparisons are inevitably being drawn with 1997. It is certainly true that the dog days of the Sunak and Major governments have strong parallels: tired, bereft of fresh ideas, unstable and miles behind in the polls. Very different is the political landscape thanks to devolution: before May 1997 devolution was conceptual rather than reality. Today, the dynamics of national politics in Scotland, Wales and Northern Ireland add a very different dimension to the Westminster landscape. In 1997, the Tories faced competition from the Referendum Party; in 2024 Reform UK is snapping at their heels. For Labour, the enormous difference is what they might inherit: in 1997, the UK national finances were in tip top condition: we had a regular budgetary surplus and the government debt was a mere 37% of GDP. Now we have a 4.5% deficit (an unbroken series of annual deficits since the Millennium) and government debt is the same size as the economy at approaching £2.7 trillion; there is no obvious headroom either for tax reductions or increased spending.

The parties are yet to publish proper manifestos, but at this stage given the constraints and the sensitivity of the bond markets it is not entirely surprising that what is on offer from the Tories and Labour in terms of economic policy is so little different: if it were a decorator’s fancy paint colour chart, it would be like distinguishing between “Elephant Breath” and “Grey Mouse”. What is not obvious is any intent to unshackle us from the lazy cross-party consensus of Keynesian fiscal policy. There is depressingly little ambition by either party to break the mould. Where is the fundamental public sector reform that is so badly needed to build a secure platform for sustainable growth with a vibrant private sector and an economy fit to take on allcomers in a period of acute competitive pressure? Who will praise wealth creation rather than bury it? It almost certainly will not happen under Labour because the unions and the Momentum wing of the party will have none of it. And Sunak is promising “stability” which is oblique speak for vote Tory and get more of the same; that should fill nobody with great optimism. We wait to be pleasantly surprised but we have no expectations.

Two peas in a pod? Or chalk and cheese

However, lest one think there is nothing to choose between Labour and the Conservatives, much of that is purely economic force of circumstance. The Tories are a known quantity and unlikely to change their spots: however much they claim to be The Lady’s heirs, they have drifted well to the left of Thatcherism and ditched her monetarist principles to end up as social democrats. Labour under Starmer has shed the Marxist mantle of the Corbyn/MacDonnell/Milne era. But the two parties have not blurred together into some indistinguishable political centre-left beige.

The two are poles apart on many aspects of policy and what might loosely be termed ‘ideology’. At its core, Labour remains firmly socialist. Listen to Starmer’s refrain: “Service. The Labour Party is back in the service of working people”; by which he explicitly means the working classes as he proudly describes his own roots. Labour still stands for equality of opportunity and redistribution of wealth; it is a question of how more than if (VAT on school fees is one obvious weapon, as is the pension Lifetime Allowance whose recent abolition Labour has vowed to repeal). Reeves outlining her fiscal plans made it clear that a Labour state will be significantly more interventionist: think tearing up planning rules; nationalisation of rail (possibly other sectors, who knows); setting up a National Investment Bank for business and Great British Energy to deliver renewables; more will become apparent. “Levelling Up” is Angela Rayner’s portfolio: she is a robust and unapologetic Corbynite. Starmer was Corbyn’s Brexit minister: he fought tooth and nail to derail Brexit and such was his denial of the result, he demanded a second referendum (some democrat!). He cannot afford to go down that route again but he is entirely in favour of realignment with the EU and EU regulations; his defence strategy revolves around pooling resources with the EU rather than committing to spending 2.5% of UK GDP on defence. Starmer drapes himself and Labour in the flag of the Union but his clear agenda is greater ceding of powers to the devolved nations. On foreign policy, David Lammy is no Robin Cook. More areas of difference will become apparent as the campaign progresses.

But lastly, just stop and think about the two leaders as individuals. Are they really two peas in the same pod? Sunak is a wealthy, middle class Wykehamist and Goldman Sachs alumnus; Stamer is a working class, radical human rights lawyer. Their very different backgrounds, perspectives and experiences inform their fundamental beliefs. Neither is better nor worse, superior or inferior. But don’t go away thinking there isn’t much to choose between them. The choice is yours. Good luck!

As we have said before when confronted with binary situations such as elections and referenda over which we have no control, rather than make bets based on no more than guessing the outcome, the Jupiter Merlin team prefers to consider the possibilities and to weigh up a range of options to cope with the result and then take action if needed. It is an approach which has stood us in good stead over more than two decades and many such events.

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.