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Our views 05 June 2023

JP’s Journal: Faltering economies or a pause?

5 min read

Despite strong employment data from the US last week there are signs that a global slowdown is underway.

Germany has been in technical recession over the last two quarters, the Chinese bounce back from Covid restrictions has been more muted than expected, and US growth remains subdued. Indeed, there is an interesting divergence between the measure of US activity. Q1 Gross Domestic Product, which measures expenditure, was upgraded last week to an annualised rate of 1.3% – not great but better than the previous 1.1%. However, Gross Domestic Income (GDI), a measure of aggregated income, showed an annualised decline of 2.3% on top of a fall in the previous quarter. In theory, both measures should give the same result. So, is GDI a better guide to trouble ahead, given that the income side of the economy may be a timelier indicator? In truth, I don’t know but it is another flag of potential recession.

The US yield curve is another widely watched indicator

If short rates are higher than longer term rates, it implies that investors see a slowdown and that interest rates will be cut – and inversion has been the case for almost a year. Looking at the 2 year / 30 year relationship, we can see that the greatest inversion was around the time of the Silicon Valley Bank failure when the difference was 1.2%; it is still around 0.5%. But there is a contrary argument – that the yield curve is a poor guide. In essence, an inverted curve keeps long-term interest yields low and it is these rates that are crucial to US consumers and businesses, primarily through the impact on mortgage rates and financing costs. As housing is a growing driver of activity it may be that the yield curve has become a less reliable indicator. But, regardless of the shape of the curve, long-term rates have risen by 2.5% in two years and I think this will have an impact.

The US debt saga

Bond markets took relief from a resolution to the embarrassment that is the US debt saga. Under the agreement, the ceiling has been suspended until early 2025, post the next Presidential election. With a bit of pork barrel politics (a gas pipeline in West Virginia) and fears about the consequence of the Treasury running out of cash, a deal has been done. So far so good. But there are monetary consequences that will impact financial conditions. The US Treasury is down to its last $39bn, a number that needs to be nearer $600bn. So, it will need to replenish quickly – through taking liquidity from the private sector via higher debt issuance. It is, undoubtedly, a better outcome than default but it is another headwind that will tighten financial conditions.

Adding to the recession debate was Larry Summers, ex US treasury Secretary. Speaking on BBC Radio 4, he cited Brexit and post pandemic monetary policy as the reasons why the UK is heading for recession. He referenced the labour market post Brexit – and this should be a major issue for policy makers. But this is a wider issue than he implied. Stepping back, Brexit has given choices about who can come in. The latest migration figures show a net increase of around 600,000; 1.1m arriving and about 500,000 leaving. This has been distorted by events in Ukraine and Hong Kong but overall net migration is giving a boost to the potential UK labour force. However, migration demographics are changing and we are taking in more skilled people. That sounds good, unless your business has relied on a pool of cheap labour. The economist’s answer is for wages to go up to attract new entrants – and that these costs will be passed on where possible. With unemployment near 50-year lows, it looks like workers in hospitality, agriculture and a whole range of services are in a strong negotiating position. This is one reason that inflation is proving to be stickier in the UK than elsewhere. However, there is also a health issue which will have implications for future government spending. Whilst unemployment is low at 4%, around 12% of the working age population is on out of work benefits and the UK now has about 2.6m people on long-term sickness. The bottom line is that there are fewer people working than pre-pandemic and this makes the UK an outlier.

More positively, eurozone inflation surprised on the downside, hitting 6.1% – a 15-month low. Unlike the UK, core inflation was lower – and food inflation is moderating more quickly. However, the European Central Bank will stay vigilant on inflation and, even if there is respite in the current quarter for German output, the growth challenges remain. Over the week German 10-year yields declined 0.2%, taking the rate towards 2.3%, about 0.4% lower than the early March peak. This trend  was evident throughout Europe, with marked declines in Swiss and Italian government yields;  I think investors are sensing a slowdown later in the year.

Credit spreads remained becalmed last week

However, in my view the all-in yields available on investment grade credit look interesting. Last week, I highlighted the attractions of sterling investment grade debt – what I did not mention was that two years ago, the yield on a mainstream euro credit index was basically zero; today it is 3.3%. Global credit strategies that can deliver a good level of income, from diversified sources, may look attractive.   

Ending on a completely different – but important note

I bumped into Azhar Hussain, our Global Head of Credit, at the FA Cup Final. We have different allegiances but these can be transcended by bigger issues. I rarely support footballers in red but a young teenager taking a penalty at half time had me cheering. He has been diagnosed with cancer and was raising money for charity via ‘100 Strikes Against Cancer’. Well done Edward. And I would like to thank Royal London for recognising the devastating impact on individuals and families of cancer through our new partnership with Cancer Research UK.


This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.