Economic data holding up for now but some weaker signals coming through, another painful week for bond investors and forestry licence issues creating negative spillover effects for Irish housing. All these stories and more are covered in this week’s insights update from BlackBee.
The global economic vista continued to be shadowed by events in Ukraine last week as the mood around the conflict darkened yet again and oil prices once more turned higher, adding to investor angst about inflation. Interestingly economic data around the world has thus far held up reasonably well. For example, last week we saw the publication of closely watched provisional March Purchasing Manager Index (PMI) data for the US, UK, Germany and Japan which for the most part outperformed expectations and indicated reasonably robust growth in many of the economies. Our chart of the week also shows that so far, we haven’t seen much in the way of downgrades to 2022 economic growth forecasts as a result of higher inflation and interest rates and the conflict on Europe’s outskirts.
That said we do expect growth to soften somewhat in the short term as economies adapt to even higher oil prices and inflation and interest rate increases (in certain parts of the world). Higher oil prices and inflation readings are already weighing on consumer sentiment in parts of the world such as in the UK and particularly in the US as petrol prices have burst through the $4 per gallon mark – last week’s University of Michigan US consumer sentiment reading was the weakest since the global financial crisis. All of this speaks to consumer spending weakening somewhat in the near term.
As we have flagged previously, we also believe the Russia-Ukraine war is more likely to impact the European economies more than others. Last week’s March IFO business sentiment reading from Germany perfectly illustrated this, with the expectations index dropping to the lowest level since the outbreak of the pandemic in 2020. On the whole then we believe economic readings are likely to ease over the next few months. We are optimistic recessions in the key economies can be avoided but the slower economic momentum in time could cause some central banks to rethink their hawkish tendencies as the year moves on.
Last week was a more mixed one for equities as sentiment around the war in Ukraine again dimmed and oil prices resumed their climb. European equities gave back some of their gains of the previous week on foot of the weaker sentiment although US equities fared better as investors bet that the economy there would remain resilient. The technology sector also enjoyed a decent week with some of the main semiconductor names rebounding, perhaps a signal that the global economy can muddle through its current issues and that the sector can benefit over the medium term.
Bond investors had another tough week last week with government bonds again suffering losses. What is very clear at present is that government bonds continue to react negatively to rising inflation rates and oil prices. However, credit markets are also struggling, caught in negative cross winds arising from the Russian invasion. Emerging market bond markets are at the centre of these crosswinds as Russian bond values have collapsed and as the US Federal Reserve embark on a sharp tightening of policy. This monetary policy tightening is something which investors could be wary of considering the sizeable amount of US dollar denominated debt owed by emerging market economies.
Gains were broadly based in commodity markets last week although the most prominent ones were again in the energy sector. Oil and gas prices have been very volatile over the last few weeks and generally should remain on the front foot should the Ukrainian conflict persist. In our view there are alternative sources of extra oil supply that could be targeted over the next few months (US shale, Iran, OPEC) and last week the US committed to boosting the supply of LNG to Europe to reduce its reliance on Russian gas. However, such is the Russian footprint in world energy markets we feel it will be almost impossible to replace its lost output in the short term. Elevated prices therefore look the most likely short-term result.
Forestry – Licensing Issues are Beginning to Licensing Issues creating negative spillover effects for housing
As any of our readers or industry stakeholders would know, the issuance of afforestation, road, and felling licenses has consistently remained below target levels for some time, but it is no longer just industry participants experiencing the negative effects. Throughout 2020 and early 2021 the US experienced a timber shortage, constricting supply and driving up prices. To take advantage of higher prices in the US, Swedish wood processors began redirecting some of its exports from the UK and Ireland to the now more lucrative US market. As a result, timber prices also rose across Ireland and the UK, which began to spill over into construction costs and subsequently house prices. Consequently, house prices increased by €15,000 and by $36,000 on average across Ireland and the US respectively.
Ireland, however, shouldn’t have been experiencing this contraction in supply because an abundance of timber was readily available for thinning or final harvest, but a lack of licenses being issued meant that much of our supply couldn’t be accessed or brought to market. At present Ireland would need to issue 170 licenses per month to ensure that 10,000 hectares are planted each year but only 50 licenses are issued per month currently on average and has remained static at this level for the past two years. This means we are not only missing out on the potential benefits of timber as a substitute to fossil fuels (as reported last week), we are now paying for the departments tardiness in issuing licenses with our purchasing power, which is eroded by inflation.