Inflation  

Inflation is on the rise, lurching in the wrong direction and posing a headache for the Bank of England. Britain’s CPI rose by 10.4% in the 12 months to February 2023, up from 10.1% in January, and well north of the 9.9% expected. On a monthly basis, CPI rose by 1.1% in February 2023, compared with a rise of 0.8% in February 2022. Core CPI went up to 6.2% from 5.8% versus a forecast decline to 5.7%.  

This is going to have the Bank of England more likely than not raising rates. Hawks will point to this as a clear sign that inflation needs tackling still, whilst doves will be pinning their arguments on the OBR’s rosy forecast for inflation to return to 2.9% this year. As I’ve consistently said, once inflation is out the bottle it’s not going to easily be put back in.  

Sterling rose to the top of the week’s range, its best since early Feb vs the dollar. GBPUSD test the top at 1.22850 - break here calls for 1.24. Sterling firmed sharply at 07:00 as markets moved to fully price in a 25bps hike tomorrow by the Bank of England.  

Stagflation  

Hello darkness my old friend: "Expectations for stagflation have remained above 80% for 10 months in a row… FMS investors have never held such strong conviction about the economic outlook" BofA Fund Manager Survey. A net 51% expect weaker global growth; while 84% say inflation going lower, whilst a whopping 88% think “stagflation” most likely macro regime next 12 months. And the top tail risk? a "systemic credit event", knocking inflation off the top spot for the first time in nine months. A third (31%) of respondents cited this as the biggest risk – up from just 8% a month ago.  

Rejuvenation  

Every silver lining has a cloud: the UK will defer plans to raise the state pension age to 68. Rejoice! But that’s because we are living for less – the average life expectancy is on the decline for the first since about the industrial revolution. Progress! I guess Covid could be a factor, or it could just modern living. Or it could be the fact we are getting poorer in real terms. 

(Federal) Reservations  

The Federal Reserve faces a dilemma today – keep the hammer down on inflation or bow to financial stability concerns. It will have reservations about hiking for sure in the wake of the SVB-Credit Suisse debacles, but it’s got the inflation dragon to slay and should continue on the path. I think the last thing the Fed wants right now is talk of cuts...but the events of the last couple of weeks may just be doing the job for the Fed. Banks won’t be lending - loan origination falls, which will bring inflation right down, is the thinking here. But the Fed will need to stay the course – every time it lifts it foot off the brakes the inflation clown car runs away from it. Nomura says cut, with some banks saying the Fed will pause – but most say the Fed will go for a 25bps hike. Market pricing is a more assured – 87% chance of 25bps, 13% chance of a pause. Looking through a wider lens, we are in a new phase of the cycle where central banks are trying to explicitly separate monetary policy from financial stability policy, which is tricky circle to square. 

Consolidation  

The market rally paused ahead of the Fed with European indices hovering around the flatline with a  in early trade on Wednesday, consolidating gains from the last two sessions. This comes after a decent ramp up from Monday’s lows so should be seen in context as a pause for now. The FTSE 100 was steady above 7,500, while the DAX moved up 0.2% to 15,229. US futures traded with a negative bias early doors after a solid day for Wall Street saw the S&P 500 rally 1.3% to recover 4,000.   

The dollar was softer though Treasury yields held firm with the 10yr around 3.60%. DXY futures retreated below 103, testing the early Feb intra-day lows. Gold pulled further away from the 1-year high struck on Monday, retreating to $1,940, probably on a bit of an unwind play here as 10yr TIPS were steady at 1.35% along with nominal rates and the dollar was weaker. Oil was a tad lower after a strong rally on Tuesday as risk caught a bid.  

Contagion?  

Stoxx Banks Index flat this morning – a sign of calm or just waiting new news? We can’t ignore the banking thingy. UBS shares were a little softer in early trading on Wednesday but remain +7% over the last 5 days. UBS says it will buy back €2.75bn in debt issued only a week ago in an attempt to further consolidate confidence. Meanwhile it’s reported that UBS is in talks to unwind the Michael Klein investment bank deal.  

Of course, it is probably less about UBS right now and more about First Republic – shares rallied 30% yesterday but are down 87% YTD. Rescue talks are helping but the situation remains fluid. BBG reports Wall Street leaders and US officials are discussing intervention, including “the possibility of government backing to encourage a deal”. FRC has hired Lazard to explore strategic options. Meanwhile Janet Yellen, the Treasury secretary, said the government would protect deposits at smaller banks to prevent contagion.