ClockWise: Postcard from a changing Europe

As a macro investor, I’ve always believed it important to do primary research, meeting policy makers on their own turf, hearing about the shared challenges we face in interpreting events and understanding how their minds work.

Over the last three decades I’ve visited Washington, Beijing, Tokyo and various European capitals multiple times for this purpose, alongside regular meetings in the UK.

This week I spent a couple of days in Frankfurt. On day one I spoke about ‘spikeflation’ risks at a think-tank meeting hosted by the Frankfurt School of Finance. There were 30-40 central bankers, government officials, academics and private sector economists present including a former US Federal Reserve Vice Chair, a Chinese central banker and a US Treasury official-turned-chief economist at a global investment bank.

Day two was the annual ‘European Central Bank and Its Watchers’ conference. This is the euro version of the Fed’s Jackson Hole symposium, but without the private jets and razzmatazz. There were maybe 250 people in a large Goethe University lecture hall. About 95% were male, a fact not lost on ECB President Christine Lagarde (nor me).

I took away five strong messages:

1. Lagarde made it clear the ECB is data dependent but she prepared the way for a possible shift to monetary easing with a June rate cut. ECB economist Philip Lane followed up to explain he's confident core inflation will continue to fall due to the ongoing lagged effects of post-Covid reopening in services and the gradual feed through of lower energy prices. Wage inflation needs to come down, but the real wage hit from inflation is mostly reversed by now. Comparisons with the 1970s, when there was a second spike in inflation, were downplayed but continued to stalk the meeting, with one professor saying she thought the world was just as unpredictable now and central banks shouldn’t be quick to declare victory.
2. There's wide acceptance (even, surprisingly, from some German officials) that the triple shocks of Covid, Ukraine and climate change mean an increase in public spending over the next few years – along with substantial private sector capital deployment – and this spending could be inflationary.
3. There was a much greater sense of the need for pulling together and risk sharing between euro countries than I've ever heard before. Granted, there's no Alexander Hamilton figure and federalisation is still a dirty word, but talk moved onto the potential issue of euro bonds to reconstruct post-war Ukraine as a new EU member – or to finance defence spending without having to rely on a new Donald Trump administration if Ukraine loses the war (the two possibilities are not seen as unconnected). Concern that populist politicians in Holland or France will go after central banks for making losses led to calls to deepen integration by buying each other’s bonds. Ironically, it’s the ‘hard euro’ northern central banks that lost the most money from their historic quantitative easing purchases as yields rose.
4. In another reversal of core/periphery roles, there was widespread hand-wringing from the Frankfurt team that recessionary Germany is the sick man of Europe and gentle schadenfreude from the Italians present that Italy is doing fine, with Giorgia Meloni watering down her anti-EU rhetoric in power (would a President Le Pen do the same in France, they wondered?). Germany needs to move on from being a converter of cheap Russian gas into manufactures exported to China. This means greater investment in education to boost tech and services and maybe greater use of their fiscal headroom to invest in German-made green tech (borrowing for investment is permissible). Looking outwards, there was an acceptance that China will need to be a major provider of solar panels and batteries, which limits appetite for a trade war. Nobody brought up the sometimes-heard suggestion that German car manufacturers are desperate to improve trade with the UK.
5. In fact, while all of the meetings both days were exclusively in English, Brexit just didn't get a mention, and nor did the UK, other than in one or two jokey asides about financial instability around the Liz Truss mini budget or concerned side-of-room questions about political instability in general. Requests by a future UK government to negotiate a softer Brexit will get a hearing, for sure, but won't be greeted by universal jubilation. The EU has moved on.

English is everywhere; Britain not so much.

How do we relate all of this back to asset allocation thinking?

The main message is that we should remain vigilant, using our Investment Clock business cycle model to respond to macro news as it happens.

Interest rates will belatedly come down on inflation considerations and this should be good for bonds, but we should not expect too much. Central banks are still nervous about the unpredictability of inflation and, like us, they’re data dependent. And if signs of a pick-up in industrial activity and commodity prices broaden, they may end up on hold again or even hiking. A US speaker reminded everyone that this is exactly what happened in the 1990s, with 1998 rate cuts followed swiftly by 1999 hikes and recession in 2000. Stronger growth would be good for stocks while it lasted, but it wouldn’t last forever. Active management remains key.

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.