Good COP/Bad COP
The headlines during the first half of November have been dominated by events at the 26th Conference of the Parties (COP 26). Inevitably, the timetable for a final communique overran and inevitably there was a compromise at the final stage.
China and India’s insistence on a phasing down of coal usage rather than a phasing out comes as a major disappointment to many and paints them as the bad cops – just as Delhi is closing schools due to poor air quality. For those countries for whom half a degree of additional global warming could be a death sentence, the amended wording is a huge disappointment, as articulated by the Environment Minister of the Maldives. If all pledges come to pass, according to the IEA, the number that could be achieved is 1.8 degrees Celsius warmer, not 1.5 degrees. While activists will be disheartened, there are some good outcomes from COP 26:
- China and the US (the two biggest emitters) agreed to work together on climate change. No concrete details yet but a welcome change of direction from China
- Countries have to come back in a year’s time at COP 27 in Egypt, with better climate plans – but there is a get-out clause
- 100 countries signed up to slash methane, more potent a polluter than CO2. Like coal, this is the first time methane has been specifically referenced
- Defined rules on international carbon-trading giving clarity to what has become an unregulated space
So, lots of aspirations and some transparency from COP 26 and a big step in the right direction in the recognition of climate change needs. To sum up, the following graph from Bloomberg illustrates the pathway(s) from here.
One of our key themes has been and continues to be climate change, including energy transition. The momentum behind climate change is significant at governmental and corporate level. This theme had a stellar 2020 but gave some performance back in 2021 until recently when better performance has kicked in again. These oscillations are not something we attempt to trade as it is important to remain exposed to such an important theme.
Flattening to Deceive?
Over the past few weeks there has been much talk of a rise in UK short term interest (base) rates to reflect inflation concerns at the Bank of England. This isn’t just a UK phenomenon, conjecture in the US has been about how many interest rate increases the US Federal Reserve will effect in 2022. Both the UK and US central banks declined to adjust interest rates upwards at their recent meetings. While the US lack of change was not unexpected, they decided to taper their quantitative easing or to put it another way, reduce their purchases of (predominantly) US Treasury securities, which has been crucial to providing liquidity since March 2020.
The Bank of England, on the other hand, surprised financial markets by not making a modest upward adjustment in base rates. Both UK and US central banks described the inflation threat currently being faced as transitory or transient. So, by next spring or early summer 2022, inflation numbers should be lower and, on the way, down. While the debate on inflation and its stickiness rages on, we have said before that a wait and see attitude seems appropriate as higher energy costs are a tax on consumers and businesses alike. A record number of job vacancies in the UK is triggering higher wages and shortages in certain industries where the pandemic has caused a change of lifestyle. Many companies will be able to pass higher input costs on to their consumers, many will not.
It is interesting to note what the UK government bond market thinks of these developments. The chart below sourced from Highcharts.com, shows the significant flattening of the yield curve from a month and six months ago. It also shows the acute steepening of the short end of the yield curve from six months ago reflecting greater concerns about monetary policy tightening from the Bank of England. The lowering of long duration yields would suggest that inflation is not a long-term problem (the peak of the yield curve is just above 1%) and that an early set of base rate increases by the Bank of England might be a policy error.
At the start of November, exposure to the climate change theme was increased by taking further profits from the digital economy theme. Continued inflows into the T. Bailey Dynamic Fund saw its assets rise above £200 million. Those flows were used to add to existing positions.
As always, we thank you for your continued support.