This week has seen markets a little more subdued after the strong rally across equities and bonds last week
That said, bond yields have remained volatile, with the market narrative that central banks are done with rate hikes coming up against some hawkish comments from Federal Reserve Chair Jay Powell yesterday. Amid somewhat weaker economic data, which implies central banks do not need to raise rates further, US equities saw their best week of returns last week in the past 12 months, as the market rallied strongly having slipped into “correction” territory as I mentioned last week.
In the aftermath of last week’s central bank meetings, we’ve seen plenty of speeches this week attracting plenty of scrutiny given the shift in the market mood towards rate cuts, despite the message from the central banks generally pointing to upside risks to rates with rate cuts not yet on the agenda. Bank of England Chief Economist Huw Pill (of the “Table Mountain” view of the path for rates) did little to contradict expectations of cuts in 2024, saying that what financial markets were expecting for UK rates “doesn’t seem totally unreasonable”.
According to Bloomberg, the market is expecting 42 basis points of cuts by next September. A day after Huw Pills speech, Bank of England’s Governor, Andrew Bailey said on Wednesday that it is too early to talk about rate cuts, and that while inflation would fall sharply in the coming months as energy price hikes fall out of the year on year figures, monetary policy needed to remain restrictive for an extended period of time, with “upside risks” to inflation including the threat of a broadening of the conflict in the Middle East. Bailey said that he is “optimistic” that inflation will be back on target “in around a two-year horizon”. However, he states that “we have got to continue to do the work to make it happen”. While they appear to contradict each other, they may both be right in the sense that by the middle of 2024, the UK economic picture may look very different, hence the market pricing of rate cuts. But until they see inflation on a sustained path to target, Andrew Bailey will not be talking up rate cuts so far in advance of them happening.
Federal Reserve Chair, Jay Powell yesterday reminded markets not to be too assured in their expectations for the path for policy rates, telling an IMF Conference, “if it becomes appropriate to tighten policy further, we will not hesitate to do so”. Powell said that “we are not confident we have achieved such a stance” that would bring inflation down to 2%” and while improved supply has helped bring down inflation so far, going forward, it may be that a greater share of the progress in reducing inflation will have to come from tight monetary policy”. The Fed wants optionality to hold for an extended period but equally to be able to hike rates further if needed. What it does not want is financial conditions easing by way of markets rallying strongly on the assumption that the Fed is done and dusted. So, Powell and his colleagues will continue to leave the potential for further hikes on the table.
We’ve had a few economic data points to focus on, including the second part of the monthly PMI surveys, showing the service sector generally in better shape than manufacturing, but on a weakening path. In the US, the services numbers were still in growth territory but fell substantially from September to October, leaving the overall composite PMI at the lowest level since May. The UK PMI services numbers remained in “contraction” in October but saw a slight improvement over September. The UK composite remained in “contraction”, as it did in the eurozone, where the services PMI declined even further. UK GDP was not quite as weak as expected however, with Q3 showing growth flatlining, against market expectations of a contraction of 0.1%. While that may not be much to get excited about, the lack of contraction means that a technical recession, i.e. two quarters of negative growth, is pushed down the road.
Last Friday saw the US publish monthly job numbers for October, and the lower-than-expected reading was taken as evidence of the US labour market showing some signs of cooling. Non-Farm payrolls were reported at 150,000 in October, below the 180,000 expected. We also saw the strong numbers from the previous two months revised lower by 101,000. The unemployment rate climbed to 3.9% from 3.8%. The US labour market is still looking reasonably solid but there is enough evidence in the leading data on temporary hiring as well as the slowing pace of the overall data to suggest that the US labour market is on a slowing trajectory. The Federal Reserve will be comfortable at the pace of this slowdown, maybe President Biden a little less so given his less than favourable polling.
We saw more reasons to expect US economic momentum to ease over the coming months in the Federal Reserve’s Senior Loan Officers Opinion Survey (SLOOS). This quarterly report surveys US banks and gauges the supply of, and demand for, credit. The report showed that banks’ willingness to lend had improved since the previous quarter, with fewer banks reporting tighter lending standards for commercial and industrial loans and for commercial real estate. A greater number of banks reported tighter standards for residential mortgages. Overall, the report was “less bad” than the previous quarter but remains at levels historically consistent with an economic recession. The terming out of debt at the corporate and household level has lessened the impact of rate hikes, along with excess savings after the pandemic at the availability of private credit. However, the longer bank lending standards remain tight, the higher the risks in terms of refinancing at higher costs, or not at all.
The legacies of an era of cheap money are still feeding through – WeWork is a prime example. Founded in 2010, never profitable, valued like a tech firm but ultimately just an office-rental business, and now bankrupt. Companies such as this will do well to survive in a normal interest rate environment. Let’s end with a fact: 42% of companies in the US Russell 2000 index didn’t make a profit last year. Halloween may be over, but there still are plenty of zombies out there …
Have a good weekend,