This Week in the Commonwealth

As Britain gears up for Queen Elizabeth II’s Platinum Jubilee—celebrating 70 years on the throne—the Commonwealth she heads is having quite a busy week. In Canada, the central bank made another 50 basis-point rate hike while fanning inflation fears. In Australia, a solid Q1 GDP report did little to quiet the lucky country’s own inflation fears. And in the UK, the scandal known as Partygate flared up again, renewing calls for Prime Minister Boris Johnson to step down. What does it all mean for stocks? Read on!

Canada Takes a Hike

The Bank of Canada (BoC) hiked its benchmark rate by half a percentage point for the second straight time on Wednesday, bringing the rate to 1.50%—the highest among major developed nations. While the widely expected move didn’t ruffle many feathers, the press release raised eyebrows for saying the BoC is ready to “act more forcefully” if needed to tamp down inflation—a seeming change from April, when BoC head Tiff Macklem dismissed talk of a 75 basis-point move.^[i] It went on to note that policymakers don’t think inflation has peaked, arguing inflation rates “will likely move even higher in the near term before beginning to ease.” Not only is the change in tone stirring uncertainty about more severe rate hikes from here, but it is further fanning inflation fears.

This broad discussion strikes us as misguided, for a few reasons. One, given this year’s inflation is a global, supply-driven beast, the likelihood any one central bank can tame it with monetary measures seems low. As a general rule, if inflation isn’t caused by monetary factors, then it is exceedingly difficult to curb with monetary tightening. Trying to do so raises the risk of error, as it runs the risk of forcing an economic contraction to destroy demand and negate supply shortages. That would in turn interfere with the signals that typically drive businesses to increase output, which eventually brings prices down naturally.

Two, the issues driving this global inflation look finite. Oil and natural gas prices, which have sent fuel and home energy prices sharply higher, remain off their early-year peaks, which is a good indication that inflation rates should ease once the wintertime jump enters the year-over-year calculation base in a few months. Meanwhile, with Shanghai reopening, Chinese factories and ports should kick back into high gear, helping ease supply shortages and shipping bottlenecks. Add to that the burgeoning evidence that consumption in the West is shifting back from goods to services—where price increases have been far milder—and there are a lot of forces standing ready to counterbalance food and fuel prices. That isn’t to dismiss higher prices’ pain or make any political statements, but we do think it should help ease fears.

Lastly, while central banks are raising rates swiftly in Canada, the US and UK, those rate hikes parallel rises in long rates. That helps keep yield curves steeper, which is inconsistent with a recession. When long rates are nicely above short rates, it makes lending more profitable and attractive for banks, which get funding at short rates, lend at long rates and profit off the spread. Plentiful loan growth should continue supporting businesses and households, which we think is an unsung positive these days.

Australia Slows but Still Grows

Australia—among the last nations to report—finally released Q1 2022 GDP this week. Headline growth slowed from 15.3% annualized in Q4 2021 to 3.1%, following the typical pattern of a sharp reopening-fueled boomlet giving way to more pedestrian growth. Under the hood, household spending grew 6.1% annualized, the Omicron surge helped lift government spending 11.4% higher, and business investment accelerated to 6.0%. But exports fell -3.4%—the second straight decline—likely due in part to China’s restrictions temporarily stalling shipments of metals. An inventory build also contributed strongly to growth, suggesting inventories may detract in the near term as a reopening China runs down stockpiles.

While many cheered the overall strong report, an undercurrent of dread over inflation lingered. Due to the way Australian power markets are structured, many industry analysts warn the spike in wholesale power prices will put several suppliers out of business, reducing competition and driving retail prices higher—basically, an Aussie version of the UK’s ongoing home energy crisis. Some warn this could put a big dent in consumer spending, especially with savings rates falling as wage growth lags inflation. While this bears watching, it is worth noting that the UK is running several months ahead of Australia on this front and, thus far, appears to be holding up fairly well. Then too, reopening likely explains much of the savings drop off—as it did in the US and UK, which eased restrictions much sooner. That suggests to us a return to normal consumption patterns, which is a rather healthy development.

Most importantly, stocks look forward—not backward. Q1 data cover January, February and March. We are now in June, and we have long observed that stocks tend to look about 3 – 30 months ahead. Australia’s feared headwinds, like those in the rest of the world, are quite widely known. Yet Australia is leading global stocks this year (likely in large measure to its sector makeup, which emphasizes metals and mining firms), with slightly positive year-to-date returns through Wednesday’s close, and the MSCI Australia Index has clawed back a good chunk of its April downturn.^[ii] Further negativity is always possible, but for now, it looks like stocks are gradually moving on from the early uncertainty.

Boris Johnson Is in Hot Water. Again.

(Editors’ Note: Our political commentary is intentionally non-partisan. We favor no party nor any politician and assess political developments for their potential economic and market impact only.)

Just three months after UK Prime Minister Boris Johnson appeared to have overcome the backlash for having attended events that violated COVID restrictions when the UK was under lockdown last year, the Partygate scandal is back in the news. It flared up last week, when the investigative report by senior civil servant Sue Gray was published, giving the public its most detailed look yet at the associated shenanigans and politicians’ behavior. Days after the release, several aides claimed the report had overlooked additional—heretofore unknown—gatherings hosted by Johnson’s wife, and leaked text messages purport to back this up.

As always, we prefer to stay above the fray and won’t delve into the personalities and the sociological implications. But the revelations were enough to renew calls for Johnson to step down. By Wednesday, 30 Members of Parliament (MPs) from Johnson’s Conservative Party had publicly called for resignation or announced that they had filed official no-confidence letters, with the calls coming from MPs in safe and marginal seats alike. When grilled by MPs at the weekly circus known as Prime Minister’s Questions on Wednesday, Johnson said he thought it would be “irresponsible” to resign amid challenges like Ukraine and the cost-of-living crisis, suggesting he is holding on for now in hopes the storm will blow over.

Perhaps that will work. Maybe it won’t. Either way, the latest storm is draining what was left of his political capital, which probably points to more gridlock. The Energy sector windfall profits tax may have enough giveaways to households in constituencies where the Conservatives have only a slim edge to skate through, but more sweeping and contentious measures will probably stay on the cutting room floor, which should help ease legislative uncertainty. Gridlock may annoy voters, but we have found it to be a balm for stocks throughout the developed world. Political uncertainty may be spiking now, which could hit sentiment, but eventually the reality of gridlock should be an underappreciated, if mild, tailwind.