Don’t Rush to Pull the Flush

With parts of the country still in desperate need of rain, and temperatures set to climb this week, there is speculation that further measures will be required to reduce water usage.  Those of a certain age will recall the heatwave of 1976 lasted much longer and led to serious water shortages, with standpipes on street corners, queues for water and slogans like ‘Don’t rush to pull the flush’!

The UK’s water sector has already received a lot of ‘flack’ for allowing sewerage to flow into many of our rivers. It is now likely to come under fire once again with hosepipe bans being introduced across a number of regions. Reservoirs are emptying, with rainfall in some parts of the country at record low levels not seen since 1911. Water companies are now bracing us for an anticipated drought in August. Sir John Armitt, chair of the government advisory group, the National Infrastructure Commission (NIC) has warned that the country will face collecting water from standpipes once again!

To avoid this, the NIC warns water companies must tackle the 20% of water currently lost through leakage – some 3 billion litres a day! A few years ago, the NIC called for £21bn of investment by 2050, about £650m a year, to pay for water security measures, increasing reservoir capacity, cutting leakage and building a network to channel water between different areas. Meanwhile, UK regulator Ofwat wants the water companies to cut leakage by at least 16% in the five-year period up to 2025.

Higher investment would require higher water bills, not what many households want to hear during a cost-of-living crisis. The alternative is that water companies would have to accept a lower return on their capital investment. However, there are already concerns about private equity ownership in the water sector and highly leveraged balance sheets. What damage would the combination of higher interest rates and lower returns do?

Drought is also a challenge in Europe. Water levels on the Rhine continue to fall and parts of Germany’s key transport artery could become unnavigable, which would not be good news for its economy.

Climate change is making our weather more extreme and hotter. Heatwaves are predicted to become more frequent during the summer. Something needs to be done given the war in Ukraine has once again highlighted the importance of food security. Why does it always take a national crisis to drive action? What is it the British Army says? ‘Proper Planning Prevents Poor Performance’.

What have we been watching?

Concerns about slower economic growth and recession, together with increased geo-political tension, saw government bond yields continue to fall. Soft manufacturing PMI activity indicators ensured that global growth concerns persist. The fall in bond yields has been quite noticeable, with the 10-year US Treasury yield, which touched almost 3.5% in June on worries about inflation, now at 2.8%. The US going into ‘technical recession’ has been a factor here.

A surprisingly strong US jobs report at the end of last week made bond yields edge back up slightly, aligning with comments from a selection of US Federal Reserve officials who said that returning to the inflation target remains the main priority. Despite these recent developments, downward pressure on yields and recession fears prevail.

European yields have also fallen, with the UK 10-year Treasury yield falling from a peak of 2.65% to below 2%. Concerns about gas supplies this winter have added to the uncertainty, with the German 10-year bund yield dropping from a peak of 1.76% to around 0.9%.  Meanwhile, the European Central Bank (ECB) appears to have been active in buying Italian bonds recycling money as existing bonds mature, helping to cap Italian yields.

The war of attrition continues in Ukraine. Tensions also re-surfaced between China and the US over Taiwan, following US House Speaker Nancy Pelosi’s visit – the first US official to visit Taiwan in over 25 years. Japan expressed concern to China over its military exercises in the Taiwan Strait.

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In the UK, the manufacturing sector PMI activity indicator dropped to a 25-month low in July to 52.1. Despite the weakening of leading economic indicators, the Bank of England implemented the biggest rate hike in 27 years, taking borrowing costs from 1.25% to 1.75%. Furthermore, inflation is now expected to peak at 13.3% in October and to remain at elevated levels throughout much of 2023. Economic growth projections have also worsened, with a recession expected in the UK from Q4 2022, which could last up to five quarters.

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In Europe, the Eurozone manufacturing PMI activity indicator contracted in July for the first time since mid-2020 with a reading of 49.8.

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The US ISM manufacturing activity index dipped slightly in July although there are encouraging signs that some supply constraints are easing. On the jobs front, the US labour market continues to surprise economists adding more than 500,000 jobs in July – more than twice the number expected. This strength added to hopes that the Federal Reserve will be able to raise rates without triggering a meaningful recession. However, bond markets continue to suggest that recent signs of economic resilience will be short-lived.       

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In China, the Caixin services sector PMI increased to a 15-month high of 55.5, as parts of the country emerged from lockdown.

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Brent oil eased lower, below $95, on concerns about the global economy and China. Meanwhile, after a brief summit, OPEC+ decided to grant an increase in oil production as requested by the US. However, the increase was just 100k barrels/day starting in September, although the subsequent weakness in the oil price suggests that the market is more concerned about the demand outlook.

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Finally, talking of security of water and energy supplies. Last week saw the closure of Hinkley Point B, which had been expected due to its age. However, some nuclear industry insiders have accused the government of a ‘huge missed opportunity’ to secure short-term energy supply as they believe the power station ‘had another winter in her’.  Hinkley Point C is not due to start generating electricity until 2027.

Read Last Week’s Alpha Bites – Taking our foot off the gas

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.