Market Insights and Education & Resources

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The Great British Sell Off: The fiscal support package announced in the UK on the weekend could make inflation even harder to control, TIM HEXT explains.

CENTRAL Banks, led by the Fed, have spent the last few months pushing hard their hawkish credentials.

We have been told that combating inflation is priority one and if it means a recession then so be it. Markets have reacted by selling off risk but also moving rate expectations a lot higher.

However, the new UK Prime Minister Liz Truss and her Treasurer Kwasi Kwarteng have taken a more unconventional approach.

They seem to be focused on avoiding recession and hoping that somehow inflation will sort itself out.

Inflation is at its heart a demand versus supply problem. Central banks can’t control supply so they try to impact demand through rates. Fiscal policy can impact supply but it needs to be very targeted.

As a large energy importer the UK has little control over energy supply, at least short to medium term.

The fiscal support package announced on the weekend is partly an attempt to help address supply problems, but markets have taken it as merely propping up demand that is already too high.

GBP 72 billion of tax cuts were made across national insurance, corporate taxes, stamp duty and income taxes. Much of it will find its way to the wealthy, with more of a propensity to save than spend.

All this is on top of energy price caps that at current rates are worth GBP 160 billion over the next three years. They at least will keep headline inflation in single digits.

The Bank of England is now faced with an even harder job to rein in inflation.

Markets have taken it that way, now pricing terminal rates above 5%. This was nearer 4% last week.

However, it is the extra supply that the bond market and currency market are struggling to assess.

At an extreme the price of 30yr UK Debt fell 10% after the mini budget. So far in 2022 UK 30 year debt has halved in price.

This all impacted on global bond markets in another tough week.

UK investors will potentially move money back onshore as their currency and rates become relatively more attractive.

Terminal rates in Australia are now back to pushing near 4.5%. Whilst domestically this looks very restrictive, global investors are not hanging around to find out.

Time will tell whether this huge gamble by Liz Truss pays off.

If global energy prices plummet, then they may get away with it. As it stands now though, markets are taking the view that the UK is falling deeper into a hole.

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Here are the main factors driving the ASX this week according to Pendal's Head of Equities, Crispin Murray. Reported by portfolio specialist Chris Adams

CHAIR Powell reiterated his message that the Fed will continue to tighten quickly, even if that threatens to trigger a recession.

This prompted market pain last week. The S&P 500 fell -4.63%, through a previous support level, and is now retesting year-to-date lows. So too are high yield credit spreads, the copper price and Australian equities (which fell -2.48%).

Elsewhere the US dollar index rose to year-to-date and twenty-year highs, US bond yields hit year-to-date and twelve-year highs, the oil price fell to its lowest point since the invasion of Ukraine, and both French and German equities broke to new lows for the year.

In the US, commodity prices, freight rates and used car prices are all falling. But service sector inflation continues to rise and the labour market has not cooled enough.

The market fears the Fed will break the economy, with rates rising too quickly. As a result, we appear to be entering the capitulation / liquidation phase of this bear market, where the orderly sell-off gives way to fear and more indiscriminate selling.

Currency appears to be at the nexus of this sell-off. There is less confidence in the British Pound and the Japanese Yen due to fiscal and monetary policies. This is driving strong flows into the US dollar, which causes stress on risk assets generally.

There is a circularity in FX markets. As the US dollar rises it increases inflationary pressure in other countries, forcing them to consider more rate hikes. The on-going sell-off in bonds, despite growing concerns on recession, also points to liquidity issues.

Bulls are pointing to extremely weak sentiment, that we are at peak inflation hawkishness and the belief that the support levels currently being tested can hold. It is also possible that the Fed may send some small signal to prevent the market becoming disorderly.

Overall, we remain cautious in the near term. However we are mindful that these episodes can present attractive opportunities on a medium-term view.

Policy and economics

US

While the 75bp hike in rates to a 3.0-3.25% range was largely expected, the Fed’s hawkish stance weighed on markets.

Powell’s comments that there “isn’t a painless way to get inflation down,” that “the housing market may have to go through a correction,” and that there will “very likely be some softening in the labour market” all point to a clear effort to change the market’s mindset and flush out any hope of pivoting.

This rhetoric, combined with the shift in “dot plots” of future hikes moved the expected rate profile higher. November is now expected to see another 75bp hike, with 50bps more in December and 25bps in February. This implies rates peak at 4.5% to 4.75%.

The Fed also increased their expected unemployment rate at the end of 2023 from 3.9% to 4.4%. Such a move would be consistent with a recession, suggesting that they are prepared to keep hiking rates into a recession.

The 2 year government bond yield rose 34bps to a cycle high of 4.21% in response.

One challenge for the Fed – and the market - is that the economic data is not looking that soft. It may also remain supported by the fiscal drag easing off and by pent-up demand in autos and services, while the backlog of unfinished homes will underpin construction in the short term.

In addition, the labour market remains tight. The difference between job openings and unemployed peaked at 5.9m, which is the highest ever as a percentage of the workforce. This creates pressure on wages.

Goldman Sachs estimate this has to fall to 2m to loosen the labour market enough to get to back to 3.5% wage growth, which is consistent with 2% inflation. So far, this has only dropped to 5.2m.  This makes it difficult for the Fed to signal a significant pivot in approach.

The market’s fear is that the pace of hikes is too quick to be able to assess their impact and the Fed is therefore making a significant policy mistake that sends the economy into recession and may trigger some form of financial shock.

In response, the Fed is saying this is not a mistake. Rather, it is what needs to happen to solve the inflation problem.

Either way creates risk to corporate earnings.

UK

The scale of fiscal stimulus in the new UK Chancellor’s “mini” budget went beyond most expectations.

The government will spend GBP45bn, equivalent to 1% of GDP. Most expected something in the order of GBP30bn. This comes on the heels of the energy pricing policy, which is expected to cost at least GBP60bn in its first year.

This largesse has been widely condemned on the premise that such strong fiscal expansion in an inflationary environment will only force the Bank of England to raise rates more aggressively.

UK government bond yields surged 35-50bps across yield curve in short order. The UK 5 year bond was yielding below 2% on 15th August and is now 4.15%.

The broader fear is loss of confidence in the UK. This is reflected in currency markets, where the GBP fell 5% against the USD over the week to reach record lows.

The Bank of England raised rates 50bps during the week, but would not have anticipated this degree of fiscal stimulus. The market is now pricing in a potential intra-meeting rate hike by the BOE, to try to protect the pound.

Japan

Intervention by the Bank of Japan on behalf of the Ministry of Finance to support the yen – for the first time in twenty four years – shows another source of stress in forex markets.

It came in response to the BOJ’s continued commitment to yield curve control and comments that there would likely be no need to raise rates for two years. While providing short-term relief for the yen, the market remains sceptical that it will ultimately prove successful, with Japan the only buyer. There is also the question of how deep are Japan’s pockets. It has US$1.3 trillion of forex reserves, but much of this is in US Treasuries, which it is unlikely to liquidate to fund intervention – although it does highlight some concerns regarding liquidity in the treasury market.

Markets

Both the S&P 500 and the NASDAQ look set to test their year-to-date lows. There are plenty of negative signals at present, including:

  1. Bond yields hitting new highs for the cycle. The ten year yield is at decade highs for the first time in forty years, perhaps signalling a regime shift. Higher rates means lower valuation ratings and the US equity market is still sitting at higher-than-average P/E ratios. This means valuation is not a supportive factor.
  2. Key equity markets in Europe have already broken to new lows and may potentially lead the US.
  3. Major stocks such as Microsoft and Google – and key sectors such as semis and software are hitting new lows. Although at this point stocks such as Apple and Tesla haven’t broken to new lows and are helping prop the index up.
  4. Sectors such as energy which have held the market up are now seeing significant selling.
  5. Market breadth remains wide as the index falls. Typically trend shifts are preceded by narrowing markets, which we are yet to see.
  6. Volatility hasn’t yet spiked to levels normally seen near a market bottom.
  7. The option market - as measured by the put / call spread - is not positioned at extremes.
  8. Real rates (nominal rates minus inflation) have risen sharply, which has been required to anchor breakeven inflation expectations. One thing to note is that real yields have been the driver of the relative performance of growth versus value in recent years, which would indicate there is risk of further rotation away from growth.

Overall, this feels like the capitulation phase is beginning to kick in. This will present opportunities, but the lesson of prior bear markets is to be careful not to jump in too soon.

There is a risk the moves we are seeing trigger forced selling. We note that US households still have high holdings in equities and some foreign central banks may liquidate to get access to their reserves. There is also now a decent carry on cash and fixed income, offering an alternative to equities.  The counter-risk, mentioned above, is that the Fed steps in with some signal to calm markets.

Australia

We continue to see the Australian market as more defensive. It trades on a P/E of 12x, versus the S&P 500 at 17x, while the economy is supported by higher savings, a less aggressive central bank, supportive terms of trade and immigration.

The issue for Australia is as much as the RBA may want to limit rate rise, there may be a limit to the gap between our short-term rates and those in the US, before it creates issues with the currency which would exacerbate inflationary pressures.


About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 30 years of investment experience (including 28 years at Pendal) and leads one of the country's biggest equities teams.

Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund 

Contact a Pendal key account manager here

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Here are the main factors driving the ASX this week according to portfolio manager Jim Taylor. Reported by portfolio specialist Chris Adams

THE market was positioned for good news on the US inflation front – and took a hit when the CPI came in slightly stronger than expected.

A strong inflationary pulse across a broad range of categories ran contrary to a prevailing narrative of softer inflation.

In an environment where the Fed is driven by data – rather than by its own forecasts – sentiment on the monetary policy path shifted quickly.

The Fed funds rate is now expected to reach 4.2% in December 2022, up from 3.9%.

Equity markets took a hit. The NASDAQ fell 5.54% on the day of the data print – its worst fall since March 2020. The S&P 500 was off 4.3%, its worst since June 2020.

Poor sentiment was compounded by pre-released earnings from Fedex, which saw quarterly EPS at $3.44 versus $5.15 consensus expectations and an even bigger shortfall on next-quarter guidance.

Management cited softer demand, weakening further into the quarter’s end, both in the US and internationally. This exacerbated concerns around the economic backdrop.

The S&P 500 fell 4.7% for the week. The S&P/ASX 300 was down 2.2%.

US inflation

Headline CPI rose 0.1% month-on-month in August, against an expected decline of 0.1%. On an annualised basis inflation is running at 8.3% versus 8.5% last month – again higher than the expected 8.1%.

Core CPI rose 0.3% to 0.6%, higher than 0.35% forecast. Annualised, it is running at 6.3% m/m, versus 6.1% expected – the highest print since March.

The key concern was the breadth of disappointing numbers across multiple buckets including shelter (34% component), new and used cars (8%), medical services (7%), food away from home (5%), apparel (2%), utility gas service (1%) and motor vehicle repair (1%).

Inflation is no longer driven by energy and food.

Housing inflation is a slow-moving part of the US CPI data. Landlord rent expectations have fallen recently but will take a while to flow through into the data.

The next biggest segment is new and used car prices. These have definitely turned down, which is helpful.

Wage pressure in healthcare is a global phenomenon and is likely to continue ticking up as wage demands are met.

More positively, airline fares fell by 4.6% in August – less than expected. This should continue to fall as airfares follow jet fuel prices quite closely, and they have reversed most of the spike triggered by the war in Ukraine.

Food inflation is finally moderating. The 0.7% increase in food-at-home prices was the smallest since December, after seven straight 1%-plus increases.

Lower global food commodity prices are starting to work through, with more to come.

Petrol pump prices are down to $3.69/gallon – 26% below an all-time high in June and the lowest level in six months.

The “peak inflation” narrative is probably still intact, but the core components remain stubbornly sticky.

Producer Price Index data (see below) suggests some relief is on the way. But it won’t matter this week.

Fed officials have made it very clear they will not slow the pace of rate hikes until they see convincing evidence that core inflation pressure is easing on a sequential basis.

The chance of a 50bp hike this week has gone.

The market has wavered between a 20%-30% chance of a 100bp hike.

The chance of a soft economic landing has fallen for two key reasons:

  1. Strength and stickiness in both goods and services inflation indicate meaningful reductions toward 2% are impossible without a recession and a big fall in employment
  2. The risk of a Fed overshoot has increased, meaning a recession gets induced almost regardless of what the data does from here.
US PPI

The Producer Price Index data was more reassuring than the CPI print.

Headline PPI fell 0.1%, in line with consensus, helped by falling energy prices. Annualised, it is 8.7%. This is down from 9.8% in July and 11.2% in June.

The key message here is that Core PPI inflation is now falling across both goods and services.

Core goods rose at a 6.1% annualised rate in the three months to August, exactly half the peak pace in the three months to May.

Core services rose 3.9% in the three months to August. This was an even bigger slowing from the 10.8% peak in the three months to March.

Consumer inflation expectations have plunged for both the three and five-year time horizons.

Other US data

The Atlanta Fed Wage Tracker grew to 6.7%.

Companies that have high turnover of low-paid workers are feeling the full force of wage pressures in the economy. Wage growth for job switchers far exceeds that for people staying with their current employer. 

Retail sales were slightly disappointing with core sales down 0.3% versus flat expectations. 

But they haven’t fallen off a cliff and may reflect higher petrol prices over the past few months, which have now reversed.

Australia

GDP data in the second quarter showed continued strength in consumer spending, driven by a rebound in services. This included a quarter-on-quarter rise of about 30 per cent in tourism-related spending.

It seems likely that the consumer hangs in there for another few months, before feeling the pinch in the December quarter as increased mortgage rates flow through to household cash flows.

Employment increased 33,000 in August. This was in line with consensus but only partially reversed the prior month's 41,000 decline.

At the same time, labour participation moved back close to its record highs (66.6%) and unemployment ticked up to 3.5% (consensus expected 3.4%).

Hours worked also recovered most of the prior month's losses (0.8%) and the under-employment rate fell to 5.9%.

It’s notable that the number of workers affected by sickness remains nearly double its usual amount (about 750,000).

The data hasn’t moved expectations for another 100bps of tightening across Q4, taking rates to about 3.35%.

Europe

The EU has proposed a redistribution of excess profits from energy companies and non-gas-power generators (nuclear and renewables), totalling an estimated EUR 140 billion.

This would involve a price cap of 180 euros per megawatt hour, which would raise about EUR120 billion.

The balance would come from energy companies contributing a third of any profit more than 20% over the last three-year average.

The plan is complex and will take time to put into practice. Each member state would have jurisdiction over key aspects.

The plan includes a binding agreement to get winter peak electricity use down by 5% – and overall 10%.

Markets

Australia held up better than other markets last week due to index composition.

Large caps did better than small caps. Small resources and REITs bore the brunt of the sell-off. Interestingly, consumer staples did not prove to be defensive in the weak market and we saw a clean sweep of negative returns across all sectors.


About Jim Taylor and Pendal Focus Australian Share Fund

Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.

Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here

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US rates are heading for 4% after inflation remained high in August. But the RBA may have more patience. Pendal's TIM HEXT explains why

ALONG with many other observers, we expected US inflation to moderate more than it did in August.

Headline CPI came in overnight at 0.1% (8.3% annual) and underlying at 0.6% (6.3% annual).

A new group of unrelated components (including vehicle repair, dental charges and tobacco) showed fresh signs of inflation, pushing the rate positive for the month.

We still expect goods deflation in the months ahead. Oil prices and most other commodities are weak.

But US wage growth is spreading inflation wider into services. Services inflation is now the battleground and labour supply lines are normalising far slower than goods.

What little patience the US Federal Reserve may have had is running out.

Fed funds now seem destined for 4% or higher. As little as six weeks ago the market was expecting terminal rates closer to 3%.

RBA may be more patient

As always, Australian bonds will follow the US. But the RBA seems prepared to show a bit more patience.

This is due to a number of factors — but the two main ones are wages and our floating rate mortgage market.

The NAB business survey showed that rate hikes are yet to have any impact.

This is not surprising as the economy is now almost fully open, many have pent-up savings to spend and fixed rates are protecting 40 per cent of mortgage holders.

The RBA remain on course for 3% cash rates by year end (either 2.85% or 3.1%).

It will likely rely on the fixed rate mortgage cliff and immigration to do the heavy lifting to combat inflation in 2023.

Bond markets are caught in the loop of pushing rates up with the Fed but also with one eye on increasing recession risks.

Flatter curves seems to be the favoured way of reconciling these two outcomes.

Credit and equity markets were hit by the high inflation numbers, but for now look to be range-trading rather than breaking down.

The only certainty for now is volatility is here for a while yet.

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Energy security and workplace relations were the big ESG themes in this year’s ASX reporting season, says Pendal’s RAJINDER SINGH

ENERGY security and workplace relations were among the big ESG themes to emerge from this year’s annual reporting season, says Pendal’s Rajinder Singh.

The volatility of energy supply amid disruption in energy markets has become abundantly clear in the last six months, leaving companies with real challenges on how to respond, says Singh, who manages sustainable Australian share funds for Pendal.

And the emerging theme of labour shortages and industrial action by workers is starting to show up as a key risk for Australian companies.

“This reporting season was quite interesting because we have this ongoing bounce-back out of Covid, while at the same time there are top-down geopolitical issues and the bogeyman of inflation and interest rates,” says Singh.

“And we’re seeing ESG perspectives play out as well.

"A lot of companies have momentum on planning for net zero and building out renewable energy targets. But at the same time they are getting hit by massive volatility in energy prices.”

“My one-liner to clients has been this: there’s plenty we don’t know about the energy transition, but what we do know is that there’s going to be increased volatility.

“That is the real challenge for companies on how they respond to that.”

Energy is a material input for many companies, meaning the cost of electricity, gas and fuel can be important factors affecting profitability.

Singh says this reporting season saw companies weathering energy volatility on the back of fixed price energy contracts entered before price rises.

“The question will be what happens when those contracts reset.

"Perhaps ironically, the companies that signed power purchase agreements using renewables are beneficiaries of this environment.

"Even though they may have signed their agreements at a higher-than-prevailing electricity prices a year ago, that’s a fraction of what the spot prices are now so they’re effectively hedged.”

Energy security issues and supply chain problems are playing out against the backdrop of decarbonisation across industry.

“Companies are scrambling to solve today’s supply chain and energy problems, but they are also in the medium to long-term grappling with decarbonisation goals.

“Previously, signing up to renewable energy, putting solar panels in and making your vehicle fleet a bit more efficient by buying EVs was easy. Now there’s a problem.

"You can’t get EVs, electricity prices are moving all over the place, and you can’t back it up with gas.

"There’s a lot more considerations that companies need to make because of this energy volatility.”

Industrial relations back on investor radar

Another ESG theme that emerged from reporting season related to labour supply, from COVID-related absenteeism to industrial action and wages.

“The federal government’s recent Jobs Summit elevated industrial relations back onto the national agenda, but it was already showing as an issue in reporting season,” says Singh.

Sustainable and 
Responsible Investments 

Fund Manager of the Year

“What we’re seeing is the importance of how companies do their human capital management – labour was taken as given but that’s changed. Labour has become harder to find.”

What does it mean for investors?

For labour, Singh says investors should seek to understand the nature of companies’ agreements with workers.

“When strikes in Sydney mean the trains aren’t working every second day, it provides a precedent for how things will get resolved going forward.

“If you’ve got an agreement that’s due for renegotiation in the next 12 months versus one that was signed for five years, that could have a material impact on your forecast growth of your labour costs.”

Look for energy security

For energy, security of supply is critical, says Singh.

Partly this can be solved simply through dealing with larger companies – “there’s security in size,” says Singh.

But it’s also important to seek security in geography, he says, using battery mineral lithium as an example.

“The two biggest sources of lithium are hard rock in WA and brine at altitude in the Andes in South America. The regulatory environment is a lot different.”

Singh says investors should seek out companies that are clearly facing up their energy problems no before the problems become more acute.

“That could be contingency plans in the short to medium term, but you also want to see evidence that the plans will enhance their transition in terms of energy efficiency, replacement of vehicles and investment in technology.

“The other thing that matters for investors is understanding the required capital expenditure.

"What’s the capital allocation to these initiatives? And is there an actual measurable benefit for the amount they are planning to spend?”


About Rajinder Singh and Pendal's responsible investing strategies

Rajinder is a portfolio manager with Pendal's Australian equities team. He has more than 18 years of experience in Australian equities.

Rajinder manages Pendal sustainable and ethical funds including Pendal Sustainable Australian Share Fund.

Pendal offers a range of responsible investing strategies including:

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Responsible investing leader Regnan is part of Pendal Group.

Contact a Pendal key account manager here

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What will Anthony Albanese’s new climate bill mean for Australian investors? Pendal’s MURRAY ACKMAN explains

THE Albanese government’s climate bill has cleared parliament, paving the way for a 43% emission reduction target by 2030 – and net zero by 2050.

How will that impact Australian investors?

Investment in electrification and mandated reductions in emissions for big companies will be features of the new plan, says Pendal’s Murray Ackman.

The bill legislates a greenhouse gas emission reduction target of 43 per cent from 2005 levels by 2030 and net zero by 2050, aligned with Australia’s Paris Agreement commitment to helping limit global warming to well below 2°C and ideally to below 1.5°C.

The three biggest sources of emissions in Australia are electricity, industry – which includes gas for industrial processes, domestic heating and the by-products of creating things like cement and fertiliser – and transport.

Source: Department of Climate Change, Energy, the Environment and Water

Electricity is the biggest category, says Ackman, a credit ESG analyst with Pendal's Income and Fixed Interest team. 

“Two thirds of electricity in Australia is generated by burning fossil fuels – mainly coal or gas – and one third is from renewables, mainly wind and solar,” he says. 

“Federal Labor policy is to increase the proportion of renewables to 82 per cent.” 

This will be done through a $20 billion investment in the electricity grid to increase the amount of renewables and safeguard the load with community batteries that are charged through rooftop solar.  

“Removing fossil fuels will require significant spending particularly in utilities and infrastructure,” says Ackman. 

“As well as government funding, there will likely be an important role for fixed income investors to provide debt to finance this spend.” 

Ackman says regulators incentivise investment in the grid, which offers opportunity for investors. 

“The way the regulator works is you get a mandated amount that you can get in terms of profit from any investments you make. 

“This will be significant for fixed income investors because much of the development will be debt funded. 

“And it will be significant for equity investors in the big resource companies who will be digging stuff out of the ground to build things.” 

Rewiring the nation

Ackman says the $20 billion in loans or equity to rebuild the electricity transmission network involves establishing a new body, the Rewiring the Nation Corporation (RNC), which will be a government-owned entity. 

“It’s a bit like the NBN using the blueprint outlined by the Australian Energy Market Operator. The RNC would partner with the transmission companies to modify and rebuild the network.” 

Another implication for investors will be in any mandated emissions reductions from the so-called Safeguard Mechanism that requires Australia's largest greenhouse gas emitters to keep their net emissions below a baseline. 

“The Safeguard Mechanism will begin operation in 2023-24 and apply to 215 entities that currently emit more than 100,000 tonnes of CO2 a year,” says Ackman. 

“They will be required to reduce aggregate emissions by 5 million tonnes a year to collectively achieve net-zero emissions by 2050.” 

These business include power stations, large foundries and mines and will each have a separate emissions reduction trajectory to be negotiated with the Clean Energy Regulator. They can cut emissions or offset them by buying carbon credits. 

Still, it's important to keep in mind that federal government targets are not the only ones that matter, says Ackman. 

Most of Australia’s emissions are from energy, industry and agriculture which is primarily the realm of state policy. 

“If you add up the state’s policies, Australia already has an effective 2030 target of 37-42 per cent emissions reductions. 

“If State renewable and energy targets for 2030 are met, 55 per cent of Australia’s electricity will be from renewables.” 

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The Great British Sell Off: The fiscal support package announced in the UK on the weekend could make inflation even harder to control, TIM HEXT explains.

CENTRAL Banks, led by the Fed, have spent the last few months pushing hard their hawkish credentials.

We have been told that combating inflation is priority one and if it means a recession then so be it. Markets have reacted by selling off risk but also moving rate expectations a lot higher.

However, the new UK Prime Minister Liz Truss and her Treasurer Kwasi Kwarteng have taken a more unconventional approach.

They seem to be focused on avoiding recession and hoping that somehow inflation will sort itself out.

Inflation is at its heart a demand versus supply problem. Central banks can’t control supply so they try to impact demand through rates. Fiscal policy can impact supply but it needs to be very targeted.

As a large energy importer the UK has little control over energy supply, at least short to medium term.

The fiscal support package announced on the weekend is partly an attempt to help address supply problems, but markets have taken it as merely propping up demand that is already too high.

GBP 72 billion of tax cuts were made across national insurance, corporate taxes, stamp duty and income taxes. Much of it will find its way to the wealthy, with more of a propensity to save than spend.

All this is on top of energy price caps that at current rates are worth GBP 160 billion over the next three years. They at least will keep headline inflation in single digits.

The Bank of England is now faced with an even harder job to rein in inflation.

Markets have taken it that way, now pricing terminal rates above 5%. This was nearer 4% last week.

However, it is the extra supply that the bond market and currency market are struggling to assess.

At an extreme the price of 30yr UK Debt fell 10% after the mini budget. So far in 2022 UK 30 year debt has halved in price.

This all impacted on global bond markets in another tough week.

UK investors will potentially move money back onshore as their currency and rates become relatively more attractive.

Terminal rates in Australia are now back to pushing near 4.5%. Whilst domestically this looks very restrictive, global investors are not hanging around to find out.

Time will tell whether this huge gamble by Liz Truss pays off.

If global energy prices plummet, then they may get away with it. As it stands now though, markets are taking the view that the UK is falling deeper into a hole.

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