What's the state of the UK economy now?

Good old Rishi.

He's just come out with his budget for the next fiscal year.

Basically all the headlines are going to be filled with talk of cutting booze taxes (great) and not much else I reckon.

It was rather underwhelming; there could have at least been some fireworks.

Here's the state of play right now, and I'll demonstrate this by looking at the move on the 10y Gilt.

Post budget, we've seen the largest move since March 2020 (Gilts up, yield down).

My initial take here is that the market is pricing in some flatter growth and inflation concerns - I wrote about this back in August on a more general theme globally.

Today, we've seen the OBR revise their growth outlook for the UK...

For this year, they're predicting a GDP growth increase of 6.5%.

Personally, I see this occurring, but their estimations beyond that I believe to be a bit over-egged.

And note: the OBR is notoriously bad at estimating any future data, apart from public sector net borrowing. Pinch of salt, please, waiter.

And I reckon the bond market is partially signifying this.

And I say partially because of this...

Here's a very interesting take from Guy LeBas from Janey.

Put simply, even with negatively real yielding debt, people still want long duration assets (long term bonds) and the fact that the issuance of said bonds is coming to a pause (pause, not stop) means that gilts will be bid like this and the yield will fall.

It's slightly paradoxical!

Perhaps we can consider the bond move very much a positional play with this in mind - flow and positioning matters bigly.

You may also be wondering what my thoughts are on inflation, right?

Naturally, since the start of the year I have been and still am team transitory.

The reasoning is due to this one concept...

Time-lags in the transmission of monetary policy.

This is a really important concept, especially in the arena of policy error, naturally.

Have a read of this paper, but I'll post the conclusion below and relate it to why I think the BoE will have to be very careful about raising rates and or tapering too fast.

In effect, there are a tonne of factors affecting inflation right now and the one big conundrum for central bankers is that many believe inflation to be a mere monetary phenomenon.

For example, you might have seen a tonne of nutters posting the chart of M1 growth (broad money) and relating this to inflation rates.

We should know by now that's bollocks.

The fact of the matter is, that policy makers are very much aware of the supply side factors that have contributed to higher levels of inflation.

We only have to look at Chinese freight rates to see this.

An almost 250% increase on the composite measure in a year is ridiculous - and some routes are even more than that, heading up to 600%!

As a proxy for congestion, we can look at the Port of LA to really come to a valid conclusion about where our inflation is coming from.

You can extrapolate this across pretty much all economies to show that there has been serious congestion, and now it has eased.

My thinking here is that the rush in traffic that we've experienced has largely been to stock inventory for Christmas - suppliers frontrunning their usual stock times.

And yes, this would largely be the same for the UK.

We can see the relatively large drop off in shipping traffic over the last 4 or so months, in fact.

This is certainly one factor that the BoE have in mind when referencing their inflation outlook.

Let's look at some others...

Is there really a wage-price spiral?

I'm not so sure of it considering the recent drop off.

Wage increases largely look transitory from this measure.

So then, how could higher prices sustain if wages are not keeping pace with inflation?

It'd be quite hard to do so...

And what about the furore over energy costs?

Anecdotally, I am probably one of the only people experiencing deflation here, since I got a £250 gas rebate (albeit it's because I hadn't submitted a meter reading for a year so was getting charged more, but I'm sticking with this line).

Well, that is in fact decreasing too...

And with prices up here across Europe, I reckon Nord Stream 2 will have 'expedited' approval.

The Russkies have already submitted the application for certification to the German regulator...

What this is likely going to mean is that we see the same conclusion for Nat Gas as we have done for many other commodities over the past year.

Let's take a look at their fate.

The assets above are not exhausted, but it's a good insight into how quickly commodities can fall when they're trading a few standard deviations above their mean...

And it's even better when you can point to factors that can ease prices.

But let's get back to talking about that transmission policy.

Let's say that these factors ease.

If the BoE were to raise rates now (let's even disregard whether the consumer would be sensitive to a 10-25bp hike), what would it mean for inflation in 12-18  months time?

Could it in fact put a dampener on growth?

Situations like this is where my belief in targeting GDP and NOT inflation comes into things.

If we were to target GDP, we would allow ourselves more leeway with not making policy errors coming out of crises like this.

We reiterated our thoughts that the BoE were in fact communicating a rate hike only to not actually do it a week or so again in an episode of the Morning Call.

And we firmly stick with this.

Although it's only off a tiny bit, the YouGov/Citi Inflation Tracker for the next 5-10 years is showing  a minor sign of waning, although too early to tell yet...

If we consider the one really nice long term trend I always bring up, then it would feel like we are in fact stuck at lower rates for longer...

That's a nice little regression trend there on 40 years of yield data...

We've currently just come off of +2 std devs.

Who says technicals & data don't match the fundamentals...

Cheers Budget 2021.