New experts, new perspectives: Macroeconomics, climate and biodiversity
- Inflation should drop back to more normal levels over the coming year to 18 months
- The adverse impacts from climate change will escalate but society has the technology to take it on
- Climate change and biodiversity loss are intertwined; we need to rapidly change our consumption habits if we are to tackle both
Investment is all about ideas. They can be drawn from grand themes or granular analysis, and they don’t happen by accident. We have recently appointed external advisors to our Investment Institute Advisory Committee – and one of the goals is to deepen the scope and quality of our research across macroeconomic, sustainability and investment issues.
Our most recent meeting of the committee saw three of those advisors join us for what turned out to be a rich, insightful and, despite the challenges the world currently faces, encouraging discussion. We focused on the short- and long-term trends affecting the global investment outlook and held separate sessions dedicated to macroeconomics, climate change and biodiversity.
The external members in attendance included some influential and experienced contributors from those worlds:
- Olivier Blanchard, an emeritus professor of economics at the Massachusetts Institute of Technology (MIT) and a former Economic Counsellor, and Director, Research Department for the International Monetary Fund (IMF). He is currently a senior fellow at the Peterson Institute for International Economics
- Nigel Topping, UN Climate Change High Level Climate Champion. Previously he was CEO of We Mean Business, where he drove collaboration for climate action among non-governmental organisations. He also established the Race to Zero, the Race to Resilience, and the Glasgow Financial Alliance for Net Zero (GFANZ)
- Nicolas Loz De Coëtgourhant Head of Sustainable Business Practices, World Wildlife Fund (WWF) in France. He previously worked for five years as a consultant specialising in sustainable development at PricewaterhouseCoopers
It was a lengthy conversation, sometimes broad and sometimes detailed. Below I have tried to capture some of the key points as we look forward to a series of equally profitable meetings in the future.
Macroeconomics, inflation, and post-pandemic life
The global economy has been beleaguered by runaway inflation, but it is now easing and should continue to do so. Central banks are committed to bringing inflation back nearer to target levels, and will likely succeed, within a year to 18 months.
It was highlighted there were two main sources, or dynamics, of inflation: Price shocks and financial tensions. The former has been driven by supply disruptions and this backdrop has had a considerable effect on headline inflation, but such shocks tend to be short-lived. Moving forward, and more importantly, we will need to be watchful of the labour market i.e., potential overheating of wages. This moves very slowly but can build to be a significant pressure over time.
In the US there is more evidence of overheating than in Europe, and the Federal Reserve could find it more challenging to push inflation below 3%. For Europe, the stronger inflationary driver has been energy costs but behind the scenes there is less overheating.
In terms of financial tensions, there is an issue with some banks’ duration risk, in that many institutions’ assets should be fine when held to maturity but may cause problems if sold on the market today. If depositors move away, then clearly solvency issues can arise. The only way the banks can counter this is by increasing the rates on money market deposits or saving accounts, which means they may need to pay a higher rate than they are getting from their own portfolios. However, central banks have plenty of tools to tackle liquidity issues in banking markets.
Life in the post-pandemic world has major implications for the organisation of firms and cities and there will be a significant amount of reallocation. It has forced people to think about the status of work in their life. But equally the fight against global warming will drive reallocation too – job types will change, for example the move to electric cars will mean a reallocation of workforces in the automobile sector. But there will be huge increases in investment in the green transition with both public and private contributions.
Public policy is fuelling this, and it is being positioned as not only the right thing to do from a responsible point of view, but also something necessary to support productivity and economic growth. However, one challenge is balancing the trend towards deglobalisation against the need to work together internationally on combatting climate change.
Accelerating the drive to net zero
The Intergovernmental Panel on Climate Change’s (IPCC) latest report offered little in the way of surprise. The scientific body, tasked by the United Nations, asserted it was confident the risks and adverse impacts from climate change will escalate with increasing global warming. And to keep within the 1.5°C limit, emissions need to be reduced by at least 43% by 2030 compared to 2019 levels, and at least 60% by 2035. We are already at +1.1°C global average warming but the data here is old, and there are suggestions we’re already at an average of about 1.2°C, even 1.3°C.1
However, more positively, the IPCC asserted we have all the technology to take on climate change. There is growing evidence that the very well understood effects of deploying at scale are kicking in across sectors – renewables, storage, electric vehicles (EVs) and now green hydrogen, which may enable things like green ammonia, green steel, green shipping and more. There is increased evidence of growth in all of these – for example, use of sustainable aircraft fuel has grown beyond expectations; battery chemistry technology is rapidly improving performance.
In addition, most modelling of the energy transition does not account for disruption. The models are ignorant to the historical fact of exponential change and use conservative assumptions around the spread of technology. Key technologies are clear: EVs, batteries, solar and wind, hydrogen, and biofuels. Globally, electric vehicles sales are markedly accelerating and that means the end of the combustion engine is on the horizon.
The reality is that technological progress is non-linear, it is pushing the cost-curve lower, meaning that low- or zero-carbon technologies are economically efficient and gaining market share. The process of combatting climate change is characterised by growing confidence in mitigation and decarbonisation technologies, while at the same time facing growing risks that we could hit some non-linear tipping points in the earth’s ecosystem.
Obstacles continue to be political will, permitting for innovative technologies, technology limitations (which continue to be challenged) and infrastructure. The investment needs are huge, and we see an even bigger role for private investors. On the plus side, policy initiatives like the US CHIPS Act and Inflation Reduction Act as well as the European Union’s NextGenerationEU framework are already stimulating significant investment growth and should continue to do so.
Biodiversity moves centre stage
Recent years have seen a rapid increase in the awareness of the risks associated with accelerated biodiversity loss. Some one million species are at risk of extinction and for many this could occur within decades. Global warming is a key driver of this.2 The World Wildlife Fund’s 2022 Living Planet Report highlighted that global wildlife populations have fallen by 69% on average since 1970; urgent action is needed if we are to reverse nature loss.3
The growing expansion of land for agricultural use is the leading driver of deforestation and in turn biodiversity loss. In the fishing industry, we know that around two-thirds of every species that are caught are either overexploited or fully exploited.4 If we do not change our consumption habits, we will not be able to reach biodiversity objectives.
Climate change and biodiversity loss are intertwined and both the result of human activity. In turn, they threaten human existence because of things like deforestation, pollution, and depletion of water resources, as well as the degradation of agricultural yields and the quality of land.
Without ambitious action, research show climate-related disasters could double the number of people requiring humanitarian assistance to over 200 million each year by 2050.5
But numbers such as these are now resonating with the corporate world. Companies are responding by identifying the issues, moving towards being able to report on their impact, and engaging with investors. The issue is less clear than climate change which lends itself to clear targets (carbon intensity) but initiatives like the Taskforce on Nature-related Financial Disclosures should provide a parallel framework for reporting on biodiversity impacts.
Last December’s COP15 summit focused on targets for deforestation, land-use footprints, and freshwater ecosystems. There is a huge focus on the agriculture sector given that it is one of the highest emitters of greenhouse gases and impacts on land-use and natural resource depletion at all stages of the value chain. This is a real game changer because now we have this macro data which can help preserve and restore biodiversity and nature. But the question is how best to use this data – how it translates to sectors and then companies.
Our challenge as investors is to identify best practices at all stages of the value chain and support the technologies and innovations – protein substitutes, alternatives to pesticides, green energy and transportation, and sustainable packaging – which help meet biodiversity targets.
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