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Our views 05 September 2022

JP’s Journal: Three lions

5 min read

England’s football transfer window closed last week. What it highlighted was the dramatic shift in the European centre of gravity which has occurred in recent years.

The Italian giants have been outgunned whilst the German and French quasi monopolies drain interest. Only Spain can challenge the pre-eminency of the English Premier League (EPL).

In England the usual suspects have been flashing the cash with Chelsea, Arsenal, Tottenham and Manchester United all in the top eight net spenders. And the figures are mind-boggling: nearly £2bn of transfers. But it is not just the big premiership beasts that have been spending. Nottingham Forest, Southampton, West Ham and Newcastle are also up there in the top eight, cheque book in hand. Understandable, perhaps in the case of Newcastle given their new ownership, but what it reflects is the riches that accrue to all teams in the EPL, courtesy of TV subscribers and thriving domestic competition. With global supporters keen to buy into the English game, it is one of our national successes.

Currency weakness

If only we were as successful in national economic terms. Sterling (the currency, not player) has been weak recently, underperforming against most major currencies. When I started in the City in 1985 the pound was almost at parity with the US dollar. It rallied over the next 20 years to reach 2USD – although a far cry from the 5USD rate seen a hundred years ago – and today we are almost back to the level when I started.

What is causing the currency angst? Whilst many challenges are not unique to the UK, we are facing some specific issues. A new Prime Minster who is keen on tax cuts at a time of ballooning debt, fraught trading relationships with major partners, internal divisions about the Union itself, a universal health service which is at risk of being overwhelmed by health and demographic trends, a transition to a net zero economy which entails upfront costs and lost tax revenue and a narrow tax base in which property is protected. Perhaps we will see a re-test of the lows in the next few months.

Data weaker but rates still rising

On the news front there was a mixed picture coming from the US. Employment data showed pretty robust payrolls growth, but slightly weaker than expected earnings growth and some suggestion of easing in labour market tightness. Despite the rise in the unemployment rate to 3.7% there was little in the data to stop another hefty increase in the US Federal Reserve (Fed) Funds rate at the next meeting. The US yield curve is now pricing a peak of between 3.75% and 4% for Fed Funds in early 2023.

So how did bonds fair last week? Badly is the simple answer. Yields on 10-year UK gilts moved up by 30bps, towards 3%. Rises were much less pronounced in other markets but the direction was the same. Globally, implied breakeven inflation moderated a bit but remains elevated in the UK with 20-year levels around 3.9%. The news that the Retail Price Index (RPI) changes proposed by the Government would not be blocked did mean some weakness at the long end of the UK index linked market but was broadly matched by softness in long-dated conventional yields.  

Credit markets were weak with investment grade spreads 8bps wider and more significant widening seen in high yield markets. Issuance in sterling has been mainly concentrated in bank debt with some fairly large new issue premiums being required to attract interest. Saying that, demand at the wider levels seems to be pretty good. Globally, corporate earnings in Q2 have generally been reasonable but as ever, there is some devil in the detail. The surge in energy and commodity profits has been a large driver of earnings growth and there are signs of a squeeze in margins outside these areas. I think this will only intensify in the next few months.

Of course, things can change. Markets are increasingly characterised by swings in sentiment. At times everything seems good and at other times it all looks bleak. In reality, it is more nuanced. Inflation will come down as economies slowdown and go into recession; a cleansing of zombie companies may be a blessing in disguise. And football may not prove to be as lucrative as currently projected. The case of Barcelona FC illustrates that there is a limit to profligacy. So, let’s hope that the overblown transfer fees we are seeing are not a harbinger of trouble ahead. They probably are.


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