Return of the Gaucho?

A good week for

• Sterling rallied between +1-2% against main currency pairs
• Government bonds also edged higher globally

A bad week for

• Equities suffered in sterling terms, falling between -0.5 and -2%
• UK corporate bonds also weakened modestly, after a strong start to the year

Latin America

Argentina and Brazil have reopened talks to form a common currency. The discussions reflect a desire to facilitate easier trade within the region, and reduce reliance on US dollars and exposure to US monetary policy. Other countries may be invited to join the common currency, enlarging the trade bloc. However, common currencies have their problems, and efforts to establish a common currency – the gaucho – in the 1980s faltered. The value of the gaucho was to be determined by the central banks of both Brazil and Argentina, but these countries were facing different economic conditions. A similar conundrum may well persist today, with Argentine inflation close to 100% and Brazil’s below 6%.

US fiscal policy

Once again, the US government must raise its debt ceiling. The debt ceiling is a self-imposed restriction on government debt dating back to 1917, and changes to it must be agreed on a bipartisan basis. The government hit the debt ceiling last week, but a boost to revenues from the tax season should provide more headroom. The Republicans in Congress are asking the Democrats to agree to spending cuts in exchange for agreeing to raise the limit. If both parties cannot reach agreement, the US government could eventually face the prospect of defaulting on its debt, but first it would utilise “extraordinary measures” to extend its ability to meet payments. These “extraordinary measures” allow the Treasury to use funds from other government programmes to make payments, and to halt non-essential government spending to preserve cash. While politicians may be happy to engage in brinkmanship, such strategies have historically hurt parties in the polls and a resolution is expected.

UK economy

Last week’s UK data painted a gloomy picture for the UK consumer. Retail sales fell by 1% in December, leaving them 2.5% below their 2019 average at the end of 2022. Strike action, impacting transport, and bad weather likely contributed to the poor outturn, but consumer confidence also remains weak. The GfK consumer confidence index slipped to -45, close to the series low. While falling real incomes are expected to continue to weigh on consumption spending in 2023, inflation is now falling, and is expected to decline below 5% by the end of the year. Indeed, if energy prices remain weak, inflation could fall faster than expected, with the level of the Ofgem retail energy price cap now expected to fall below the level of the new Energy Price Guarantee, due to be implemented in April. If inflation falls faster, this puts less pressure on household spending.

China economy

China’s population has fallen for the first time in sixty years. In 2022, China’s population fell by 850,000, to 1.41bn. China’s demographics are likely to become more of a challenge, with a large cohort of workers aging and a low birth rate. Government officials are encouraging families to have more children, easing restrictions on family sizes, but 2022 saw almost a million fewer babies born than in 2021. In contrast, India is already believed to have surpassed China to become the world’s most populous country in 2022. India faces more favourable demographics, with around half the population under thirty.

Bank of Japan

Japan’s Central Bank will soon be under new leadership. The current governor, Haruhiko Kuroda, is due to step down in April and Prime Minister Fumio Kishida has confirmed he will nominate a new governor next month. Given Kuroda’s dovish stance on monetary policy, a change in leadership could lead to more aggressive action from the Bank of Japan (BoJ). In December the Bank took its first steps towards monetary tightening, easing the restrictions of the Yield Curve Control mechanism and allowing bond yields to rise very modestly. While inflation remains lower in Japan than in other developed market economies, it has risen and, with Covid-19 measures now eased in both Japan and China, the economy is normalising. Moreover, the BoJ’s controls to keep Japanese bond yields low have led to several currency interventions, seeking to support the yen.

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