Between the Devil of Recession and the Deep Sea of Inflation

Three percent may seem an inauspicious number, but it certainly caused some headaches last week. Firstly, UK inflation is running at 3%, over the Bank Of England target of 2% and obliging the Governor of the Bank of England to write a letter of explanation to the Government.

Secondly, on Friday, US markets in unison fell by over 3% as panic once more swept through financial markets. The week ended how it had began with some faltering rallies in between. The main catalyst for the capitulation was the U.S. payrolls decline. The jobless rate of 5.5% was the biggest increase since 1986 and the fifth consecutive month that the US had lost jobs. The no recession consensus that had been building is now under considerable pressure on both sides of the Atlantic.

The final nail in the coffin was the price of oil awaking from its temporary slumber. Crude prices surged over $15 Dollars in the final two days of the week, adding $11.31 on Friday alone to close at a new record high of $139.12. Fears of war in the Middle East and a US recession created the perfect Storm.

Even before equity markets opened for the week June had already started badly for domestic markets. In early trading, the Pound fell sharply against the Dollar on weak manufacturing data. Then equity markets opened to an all out blood bath on shares in Bradford and Bingley. News had already leaked over the weekend that the Bank was in trouble, and so it proved with shares pushed down to 60 pence at one stage. The bank has now fallen an incredible 87% since its peak in 2006. Barclays Bank has fallen less in percentage terms since its peak, but the size of the bank has made its collapse all the more damaging. Last week Barclays closed the week at its lowest level since March 2003 on capital adequacy concerns.

Recently there were signs of a slowing but not capitulating UK economy, now things are looking graver. As house prices inch lower, consumers feel poorer than six months ago. This in itself is not too dramatic, but combined with oil prices not far off record highs and food inflation on the up, consumers not only feel poorer, they actually are.

There was no surprise from the MPC with its rates decision last week, but the ECB ruffled some feathers by indicating that they may have to raise rates as soon as July. The DAX and CAC have lagged behind other markets, as the prospect of higher rates proves unpopular with equity investors. Bernanke dropped some large hints that the Feds bias was moving towards tightening rates after an easing cycle, but the recent payrolls data shows that the Fed like many other central banks, is stuck between a recessionary rock and a inflationary hard place.

Next week has the potential to pour more misery on an already depressed market. The week starts with UK PPI data, and the latest House price balance from RICS. Tuesday sees the release of UK industrial production figures and the US trade balance. The weeks hottest ticket is potentially the US retail sales data on Thursday. If the US consumer starts to seriously tighten their wallet, there could be wide reaching international consequences.

Bespoke Investment Group has some interesting data on the performance of the Dow Jones following capitulations such as Friday. The average change following a 3% drop has been 0.11% the following day and 0.28% the following week. Over the last decade, the average performance the next day has been 0.63%. In addition when the market rises 1.5% one day then drops 1.5% the next day (as the Dow did on Thursday and Friday), then the following day is up on average 0.14% and 0.56% over the following week.