Macro Moments Weekly: Past the beginning but not near the end

This week we have seen the first data evidence of the economic impact of the Iran conflict, and it hasn’t been as bad as feared. Sure, consumer confidence in Germany fell, but only a little, and the Italian consumer data was weak. But European manufacturing Purchasing Managers Indices (PMIs) actually got better, while service sector data was weak enough to dent the overall indices. These data suggest the general sentiment that it is early days, this conflict may not last, why worry for now? Easter holidays are around the corner. A stoical, sanguine approach.

But I believe we should worry, because in the data are two clear signals. First, consumers are preparing to tighten their belts, spend less and save more. Second, in manufacturing, input inflation has leapt, and supply lines have become markedly longer. These are indications of two trends: Buy now, since it will be more expensive later, and significant supply disruption is already appearing. Simply put, getting stuff in from Asia and the Far East is going to take longer and cost more. Both are shouting future inflation.

Understanding the tentacles of inflation is going to catch out both economists and consumers alike, in my view. Too many of the former are looking at the direct impact rather than the indirect effects that consumers see: We can all see that petrol prices are rising sharply, and diesel even more. We can see the price of a mortgage rise, especially for the million or so people in the United Kingdom whose five-year fixed-rate loan expires this year. Mortgage rates in excess of 4.5%—a jump from 1.5% in 2021—are going to hurt budgets.

Next PLC, the UK clothing retailer, summed up the situation in its annual report this week: “Beyond the next three months, if we see these costs persist, then we will begin to pass these costs through as higher pricing.”¹ So that would be in June, just before the consumer gets hit by rising domestic bills, with current estimates at +20%. Second, from Next, “We have no feel for the medium-term effects on supply chain resilience.”²

The message is to buy your summer wardrobe now, as it may be more expensive later, and that’s only if we can even get some stock to the shops.

So how much of this bleak message is now in the price? After all, the OECD cut UK growth forecasts without factoring in the three interest-rate rises the market is now expecting. It is the same for Europe.

The upcoming company reporting season will probably not help, as it is just too soon to see or even sense a definitive trend. Caution and uncertainty will probably be the most-used words. Higher prices could hit some economies hard, like Germany, while other nations, like Brazil and Mexico, could even benefit from higher oil prices.

The 10-day truce announced by US President Trump expires on 6 April, and it is hard not to believe negotiations will run up to the very edge of that deadline. By then the Strait of Hormuz will have been closed for five weeks and a day. Broadly speaking, equity markets are down 4% in US dollars year-to-date. Markets will continue to sway with every news bite.

This fall is not enough to reflect the full cost of the stagflation that would likely occur if the oil price were to rise to US$140. Would that be the cost of the Strait of Hormuz being shut for three months? The bond markets have moved to price significantly more of that risk and perhaps have priced most of it. Equities have moved less so.

And when it is all over, what does the recovery look like? How soon will oil and liquefied natural gas flow from the Gulf Cooperation Council countries? How long will it take to get to where it is needed across multiple questions. Good questions, but the market will not care; it will rally first and think later.

The key for investors is to have the capacity to act, rather than react. I am not sure if, collectively, investors, especially equity investors, are in this position. They may still react to negative news by selling assets—and therefore, downside risk continues.

But just as time clarifies the issue, time also enables positioning to change, time creates opportunity, time creates resolution. The market is like those children in the back of their parents’ cars, driving long distances for their Easter break and asking, “Are we there yet?” The answer is always no, but to my mind we are well on the way.

Parting shot

Using second-hand car data, you can see the accelerated depreciation rates for electric vehicles, which is partially due to new and cheaper models coming from China and partially due to buyer dislike. Will that reverse, especially if shipping new vehicles from China slows significantly, and fuel prices stay high?