With the cost-of-living crisis showing no sign of abating, this month’s Market Update considers the risks of energy and food shortages this winter, and a longer-term global recession - and what governments (and the financial sector) could do to help, while ensuring that emissions targets and net zero goals are met.
After the brief glimmer of a market recovery in July, markets fell back over the course of August. The FTSE World Index, measuring the performance of developed markets, declined 3.23%. European and US markets bore the brunt of these falls, with the Euro Stoxx 50 index down 5.11% and the S&P 500 index down 3.97%. The UK market, which has proved to be more defensive over the course of 2022 thanks to its exposure to energy and mining stocks, fell 1.74%.
(All returns are sourced from FactSet and are reported as total return for the period 01/08/2022 – 31/08/2022)
"As consumers and business owners face tough decisions about energy or food, and cutting jobs or closing up shop, the next UK Prime Minister has a difficult winter to navigate."
The continued volatility in financial markets results from the further rise in inflation, placing pressure on businesses and households across the world as both costs and interest rates rise. Grain and energy prices saw another price spike in the middle of August, the former due to the continued war in Ukraine and, in particular, Russia stating they were no longer interested in pursuing diplomatic negotiations, and the latter as Saudi Arabia signalled it could cut its supply of oil. This has highlighted the risk of energy and food shortages as we approach the winter months in the northern hemisphere.
These spikes are still some way below the highs reached in June, but the impact is only beginning to be felt. Whilst oil and gas majors and leading grain traders have reported record profits this year, local businesses are feeling the pinch. Pubs, restaurants and cafes are reporting potential average annual cost increases of £20,000 while small manufacturers are expecting a rise of £70,000. Considering the risk of a global recession, where consumers cut back spending, many small business owners are understandably worried.
As consumers and business owners face tough decisions about energy or food, and cutting jobs or closing up shop, the next UK Prime Minister has a difficult winter to navigate. Over the short term, governments across the world must provide support packages to avoid a long lasting and deep recession but this will have to be balanced with the cost of servicing government debt as interest rates continue to increase.
In the long term, the way to avoid such scenarios being repeated is to continue the shift from fossil fuels to solar, wind and other forms of sustainable energy supply while also focusing on energy efficiency to reduce demand. Not only will such investment ensure the world delivers on its climate goals, but it should prevent Russia from being able to hold the world hostage again over fuel supply.
Over the course of the summer many parts of the world experienced extreme weather phenomena. Large parts of South Asia, the US, Europe including the UK, East Africa and China all experienced drought conditions due to soaring temperatures, while floods in Korea resulted in the destruction of many crops. The UK’s Met Office issued its first ever red weather warning related to extreme heat while wildfires and extreme heat resulted in a surge in excess deaths across Europe.
The impact of events like these becoming more regular, coupled with a likely increase in global conflicts, will be catastrophic for economies and it is estimated that global GDP could fall by 2% by 2050 as a result.
"The share of renewables for global energy supply is now at 30%. This is encouraging, as once renewables represent the majority of energy supply, they will begin to determine energy prices, reducing the fluctuations we have seen in recent months."
We therefore welcome the International Energy Authority’s latest electricity market report which confirmed that renewable power generation is growing faster than overall demand in 2022. This has resulted in a slight decline in global power sector emissions, despite rising coal use in Europe amid the ongoing gas crisis. The share of renewables for global energy supply is now at 30%. This is encouraging, as once renewables represent the majority of energy supply, they will begin to determine energy prices, reducing the fluctuations we have seen in recent months.
Another encouraging sign of progress is the UK's Energy Security Bill, which has been introduced into Parliament. It includes 26 measures that will bring £100 billion of private sector investment by 2030 and create 480,000 green jobs through new clean domestic energy supplies.
However, if the world is to reach net zero by 2050, more needs to be done. In the US, the Inflation Reduction Act, which includes a number of commitments to achieve President Biden’s net zero goals, had to be watered down to get the support it needed to pass through Congress. At home, the UK high court has ordered the government to outline exactly how its net zero policies will achieve emissions targets, after a legal challenge from environmental groups.
The judgement means that the Department for Business, Energy and Industrial Strategy must now prepare a report explaining how the policies outlined in the net zero strategy would contribute towards emissions reductions and present it to parliament by April 2023. We look forward to the outcome of this report.
Whilst government policy is important, the financial sector has an equally important part to play in limiting climate change and reducing the volatility of energy prices. The Glasgow Financial Alliance for Net Zero, formed following COP26 last year, has published a consultation on measuring the alignment to net zero of financial institutions. This is a step forward to ensure we can accurately measure the progress of a company’s net zero commitments and reallocate capital appropriately to ensure the transition to a net zero economy is successful.
Like others we believe that the remainder of 2022 is likely to be difficult. Markets are likely to swing in both directions depending on economic and geopolitical news, but we do not expect inflation to ease until next summer.
The cost-of-living crisis and the heatwaves we have experienced this summer highlight the desperate need for investment in sustainable agriculture and renewable energy. However, as we have written before, these are long-term solutions and we are in the midst of a short-term crisis. We await the commitments the new UK Prime Minister will make to ease the burden on households whilst investing to ensure the next generation does not have to worry about a lack of food or energy.