The greatest party that never happened?

September 01, 2023

Or….if at first you don’t succeed, try again.

Key points

  • There are signs that the US labour market may be softening, but the risks on wages continue to be skewed to the upside with the unemployment rate remaining so low.
  • A pause at the September FOMC meeting looks relatively likely, on an assessment that rates are already restrictive, with the door open for additional tightening.
  • The September ECB meeting may be a live debate, as recent inflation data has surprised to the upside.
  • Recent Japanese consumer data continue to surprise to the upside and all signs continue to point towards normalisation in monetary policy.
  • As we approach year end, there remains plenty of debate and uncertainty with respect to the economic and macro trajectory.

Treasury yields declined over the past week, on signs that strength in the labour market may be softening. The JOLTS Index recorded 8.8 million unfilled jobs last month, now materially lower than the levels approaching 12 million seen earlier last year.

However, job openings nonetheless remain at levels well above pre-pandemic norms and weekly jobless claims data are not signalling a material downturn in the labour market for now. Later today we will receive the latest payrolls update, but we are sceptical that policymakers will be too quick to jump to a conclusion that the economic backdrop is changing too quickly.

In conversation with policymakers, we continue to detect concern that wage pressures could continue to build, even as hiring slows, as workers seek to recoup past losses in real terms in the wake of inflation.

Headlines showing that an average UPS truck driver now earns around USD170,000 per year, whereas store managers at the ‘In and Out’ burger chain can expect to take home USD160,000, have served to highlight how compensation for many service-based roles continues to get bid higher.

Elsewhere in the economy, salaries for higher earners (such as bankers and brokers) have flatlined and this has kept a lid on average hourly earnings, but the risks on wages continue to appear skewed to the upside with the unemployment rate remaining so low.

Once labour market data is out of the way, the focus will then switch back towards the inflation backdrop. July CPI data was relatively benign, following a series of more disappointing prints. This initially appeared to feed hope that progress was being made back towards the 2% target.

However, we see some risk to a higher August print due to pressure on fresh food prices. In assessing trends in PCE core data, it strikes us that inflation may be getting stuck around 3-4%, which will be uncomfortably high for the Federal Reserve.

A policy pause at the September FOMC meeting looks relatively likely, on an assessment that rates are already well into restrictive territory. However, at a minimum, we think that Powell will continue to keep the door open for additional policy tightening at subsequent meetings in the months to follow.

For sure, we think that projections for rates to be cut in H1 2024 will continue to be pushed back, and against this backdrop, we think that it will be difficult for yields to decline much further.

In the Eurozone, this week’s inflation data surprised slightly to the upside versus consensus estimates. This will keep the September ECB meeting a live debate. However, comments from Schnabel and others suggest to us that there is increasing attention being paid to downside economic risks by Eurozone policymakers.

Eurozone data over the summer has been relatively weak, on aggregate, and with monetary policy now in restrictive territory, we think there is every reason to think that Lagarde will want to endorse a pause at the next meeting.

Ultimately, data will determine whether one more hike to 4% will be necessary, though we are inclined to look for softer prints on Eurozone economic activity and inflation in the coming months, and this would argue that ECB rates have already reached their peak.

This week’s Japanese consumer data continue to surprise to the upside. Retail sales grew by 2.1% in July and are now up 6.8% on a year-on-year measure. Bank of Japan’s Tamura suggested that the central bank’s price goal is now in sight and although there is debate on this with other Board members, all signs continue to point towards a further normalisation in monetary policy in the coming weeks and the months ahead. We continue to look for a revision to inflation forecasts in October, as a prelude to policy action, and weakness in the yen will only support the case for this.

Elsewhere, the past week was relatively quiet in financial markets. In hindsight, there was little new information coming from the Fed’s Jackson Hole meetings. In many respects, in the past couple of years, it has seemed the case that the ECB’s summer Sintra meeting has become the ‘new Jackson Hole’.

In US politics, coverage of McConnell publicly freezing in the midst of a press conference has led to public sympathy for a respected public servant. However, with the likely choice at the next election being two octogenarians, it does beg the question of whether individuals at this stage of life are best placed to serve in the highest levels of office.

In credit markets, supply will increase materially in the coming week, and it will be interesting to note how much of a concession issuance requires, to be placed. Broadly speaking, our sense is that compared to earlier in the year, investors having been moving overweight in both credit and duration exposure, and consequently any incoming information causing this thinking to be reappraised could lead to a period of more challenging market conditions once more.

Looking ahead

As we move into the final third of the year, we would reflect that there remains plenty of debate and uncertainty with respect to the economic and macro trajectory between now and the end of 2023. Policy is in a data-dependent mode, and there remains sufficient uncertainty with respect to the growth as well as the inflation narrative. This suggests to us that all possibilities remain in play.

The second half of August has seen fixed income and equity markets retrace most of their losses from earlier in the month, with volatility dropping. However, as market participants return after the summer break, it will be interesting to see if these calm conditions can persist long into the fall.

Although this may sound like common sense to position to add on weakness and sell into strength, it will always fascinate how market participants can have short memories and become complacent.

Yet, noting how pre-sale tickets for Fyre Festival 2 have already sold out, notwithstanding the debacle of the first edition (and without any location nor line-up being booked), it is perhaps not too surprising to see how easy it is for some to get swept away with the hype and momentum, only to end up with buyer’s remorse. Indeed, there are aspects of the recent AI frenzy which are starting to look bubble-like.

Yet FOMO is unlikely to be a winning investment strategy in the midst of a policy tightening cycle. There may be every chance that this is replaced by the Joy of Missing Out in periods ahead.

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