Investment Comment
1st September 2023
Good news for people who like bad news
After a challenging start to August, equities have rallied over the last 2 weeks as optimism increases that the US economy could pull off a soft landing, as weakening economic data points to a further slowing in activity. Bad news for the economy is being treated as good news for markets as it implies that monetary policy tightening is having an impact, which should bring down inflation and may mean that the Fed can pause interest rate hikes.
Jobs and economic data
As headline inflation has fallen in the US, concern has focused on “core” inflation and particularly wage growth as the labour market remains tight. While falling inflation is a necessary condition for an easing in monetary policy, Fed policymakers have indicated that they need to see labour market weakness before any interest rate cuts are forthcoming. To this end, slowing labour market data is encouraging for investors hoping for rate cuts sooner rather than later.
The ADP National Employment report on private sector payrolls showed a lower level of growth than expected with wage growth for both job-changers and job-stayers slowing to their lowest levels for 2 years. We’d note that these numbers remain very high compared to pre-COVID but there are signs of a softening in the US labour market. The latest JOLTS (Job Openings and Labor Turnover Survey) report also showed weakening employment conditions in the US, with the number of new job openings falling to 8.8m, the lowest level since 2021, and well below expectations. While the number of openings has come down, there are still a significant number of jobs per unemployed individual and that ratio remains markedly higher than pre COVID levels.
Another factor was the weaker-than-expected consumer confidence data from the Conference Board. The report was pessimistic with perceptions of the current environment and future declining, indicating that consumers may finally be feeling the pressure of higher interest rates. In a nod to the employment data, the survey highlighted that the ratio of those that say jobs are plentiful versus scarce has fallen sharply to its lowest level since 2021.
Finally, in “bad” news, we had a downward revision to Q2 US GDP, showing that the economy may have been weaker than the first reading implied. The US growth rate was revised from an annualised rate of 2.4% down to 2.1%. Alongside this core PCE (Personal Consumption Expenditure) inflation, the Fed’s preferred measure of inflation, was revised down, bringing the reading closer to the central bank’s target level.
This combination of lower real output, receding inflation and moderating employment conditions should provide room for the US Federal Reserve to stay put at their next meeting and may well call the top in US interest rates.
Later today we get further US employment data with the non-farm payroll report, which will be the next piece of the puzzle for investor sentiment as investors look for an economy that is neither too hot nor too cool, which could support a resurgence in the soft-landing narrative.
European inflation
We’ve talked a lot about the UK’s inflation problem and its outlier status but across the channel there are similar signs of “stickiness” with both German and Spanish inflation picking up in July.
This divergence between European and US inflation sets a tricky backdrop for the European Central Bank (ECB) when they meet in a fortnight. Market expectations suggest a 50% chance that the central bank feels it needs to hike by a further 25bps at that meeting and with economic growth weakening, raises the spectre of stagflation.
In the UK, expectations are for 2 further interest rate rises, albeit this week, Huw Pill (the Bank of England’s Chief Economist) suggested he would favour holding rates at 5.25% rather than raising them higher. However, before you get excited, he favours holding them at that level for the next three years, which would put continued pressure on the UK housing market. Data released this morning by Nationwide, show that the fall in house prices accelerated in August, falling 5.3% year-on-year, much worse than expected. More bad news but again it seems increasingly clear that there is little need to tighten policy further from here.
Gareth Thomas Head of Investment Management
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