We have forecast a better year for bonds and equities in 2023 as inflation comes down and interest rates peak. This predicted market performance has already started to be seen in January. We continue to worry about the retreat from globalisation and the tensions between the big powers and the trade blocs, which will have an impact on sectors and companies.
The news that Germany has now relented in its decision to send tanks to Ukraine will be welcomed by all supporters of a Ukraine striving to defend its homeland and recapture lost territory, but it means a longer and more brutal war. It is good for the western defence suppliers. It reinforces economic activity that divides the world into rival groupings developing their own military vehicles, systems and supply. It will underline the work being done by the US to onshore more of the components and materials needed for weapons – and lead the NATO allies to be even more careful about Chinese involvement in technology and investment that could wander into defence products.
Chinese components are no longer welcome in specialist metals and minerals, in microprocessors, in communications systems and much else that powers a modern army. The US and its allies want to have their own supplies at home, or else are seeking imports from friendlier territories. This means many investments in new capacity in friendly places.
US Act ruffles European feathers
US President Joe Biden’s Reduction of Inflation Act contained a $369bn package of incentives, subsidies and tax breaks for green investment. It aims to hoover up footloose world investment in electric vehicles, batteries, green energy, electric heating and the varied products of the green revolution.
It wishes to enforce rising levels of domestic manufacture in the US. The subsidy of up to $7,500 to buy a new electric car requires the manufacturer to secure at least 40% of the critical minerals from US sources this year, rising to 80% after 2026. Half of the battery for the vehicle needs to come from the US this year, increasing to 100% after 2028. The manufacturers will have to document the supplies to establish their right to offer the price cut and subsidy to customers.
There are other state inducements for people to acquire heat pumps, insulation, heat pump clothes dryers, electric cookers, improved home wiring and less draughty doors and windows depending on criteria for entitlement. There is also schemes for buying electric commercial vehicles and a sustainable aviation fuel credit.
The European Union (EU) has complained about these policies, fearing its companies will lose out. It is also threatening retaliation, looking to design a counter package of its own. Whilst there is considerable enthusiasm for such an approach, there are problems over whether it can be afforded -and who might pay.
The Germans are not keen on the idea of a new EU-level fund paid for by further EU borrowing.
The Germans are not keen on the idea of a new EU-level fund paid for by further EU borrowing, on top of the €800bn Recovery Fund in place. Less well financed member states are angry with Germany for its €200bn energy policy of domestic support as they do not have the money to do something similar.
There is general agreement on extending the suspension or relaxation of state aid rules, allowing countries greater freedom to introduce tax breaks and subsidies on the road to net zero, following the similar relaxation for the Covid-19 recovery. The Recovery Fund itself, and the Just Transition Fund, are already geared to the wider task of cutting carbon dioxide emissions and promoting green technologies. The EU has set tougher targets for reductions in carbon dioxide and higher targets for renewable energy by 2030.
The President of the European Commission, Ursula von der Leyen, recently argued for the relaxation of state aid rules but also warned against going too wide and too long with the changes. She worries it could have a “fragmenting effect on the single market” given Germany’s superior borrowing power and ability to spend a lot on trying to buy advantage for its industry. There is talk of a new European Sovereign fund this summer to offer more money to poorer nations, though there is no agreement on how extra cash will be raised for such an initiative.
Slower growth likely
It is likely the EU will find a bit more money, mainly from its nations, to build the subsidy pile. The US is in talks and may abate some of the rigours of its Made in the USA campaign at the margin to reduce the complaints from EU companies with US investments. The energy sector in the EU has become a tangled web of consumer subsidies, price controls, business subsidies and windfall taxes as the governments and EU seek to cushion the blow of higher prices and at the same time accelerate a big pivot away from such dependence on fossil fuels. It appears this energy-sector model may now spread more widely into areas such as heating, battery and vehicle manufacture as the US and EU struggle to attract more of the investments and technology – and as the west seeks to displace China from so many supply chains.
It means slower growth and higher costs than allowing unalloyed global competition. Investors will be able to find some winners amongst those companies that get the government support to establish new plants in safe countries. There will be good profits made from selling subsidised products to consumers who are still needing more persuasion to buy into the electrical revolution. There will be more demand for “electric everything” and for new networks to supply the power.
The aim is to transfer not just the activities and resources from the China bloc, but also the profits and tax revenues. This will help quoted companies in advanced countries, though the extra turnover and profits are likely to be be subject to somewhat higher taxation as governments seek to offset the extra costs of an interventionist policy.
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