MARKET expectations solidified around a 25bps February hike after the latest US CPI data suggested inflation had peaked and was showing a clear downwards trajectory — even as labour markets remained strong.
But more evidence is needed to support the narrative that inflation has well and truly peaked and a downward trend is sustainable.
It’s looking increasingly like the US will hit its debt ceiling limit in mid-January and exhaust extraordinary measures by June.
Unlike recent debt ceiling negotiations, this is shaping up like the 2011 fiscal showdown which resulted in a downgrade of the US credit rating.
That downgrade was materially disruptive for financial markets, so this could develop into a major story in 2023.
It will be important to monitor this closely in coming months.
It’s looking more likely that the UK and Europe recessions will be shallower than initially thought — or even avoided.
This is due to several things: a sharp decline in energy prices, a lower CPI print and industry benefitting from a faster-than-expected China reopening.
A scenario of more-resilient global economies, a potentially weaker USD and tight labour markets could lead to rates staying higher for longer.
If that turns out to be true, returns would likely be capped, particularly for sectors that have been most leveraged to lower rates.
Australian retail spending remained strong over the holiday period. Inflation at 7.4% has locked in a 25bps increase at the RBA’s February meeting.
We’ll get more clarity with further data in the coming week including Empire State manufacturing data on Tuesday; retail sales, industrial production and homebuilder sentiment on Wednesday; claims & housing starts on Thursday; and existing home sales on Friday.
In the US, headline CPI was in line with expectations at -0.08% for December. Core CPI rose 0.3% on the month.
Year-on-year headline inflation declined from 7.1% to 6.5% in December — the lowest reading in the US since October 2021.
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The driving force behind this was the sharp monthly drop (-4.5%) in energy, with gasoline prices down 9.4%.
Gas prices were down 1.5% in December (YoY). On the current trajectory that rate will fall below -20% by March.
We also saw a material slow-down in food inflation after recovery from droughts which affected fruit and vegetable prices. Food inflation has now reached its lowest level since early last year.
On a last-quarter basis, core CPI has grown at an annualised rate of 3.1%.
The key contributor is deflation in core goods (about 20% of CPI). In contrast, monthly services inflation (about 60% CPI) has decelerated to 0.5% vs an average of 0.6% in the third quarter.
Declining used car prices have continued as the biggest driver of goods inflation.
Deflation has now moved into new cars where we saw the first price decline since January 2021. It’s expected this will continue based on anecdotal evidence of auto players cutting prices. (For example Tesla has cut prices globally by up to 20%.)
Services inflation is so far proving to be harder to break. Core services were up 0.5% in December (a 3-month annualised rate of 6.1%).
Shelter inflation has accelerated to its fastest growth in 12 months (+0.8%). But this is expected to moderate significantly through the second half, given deceleration in asking rent growth.
Core services (excluding housing) rose by +0.3% for the month. Hospital services was the biggest surprise, up +1.5% — the biggest jump since October 2018.
This increase is well above the trend of +0.2% per month due to seasonal issues and is expected to return to trend this month.
Overall, adjusted core inflation excluding rents and other Covid-distorted components (eg vehicles, airline fares, lodging, and health insurance) rose 0.3% in December.
This was slightly up from Oct-Nov 2022 but well below the spikes seen in Jun-Sep last year.
Labour market data shows hourly wage growth is slowing in temporary and permanent employment.
If this continues downward it should provide the Fed some comfort that the inflation trend has clearly moved lower.
Jobless claims remain low at 205,000 despite pain felt in the technology industry which continued to see further job losses this month.
However, low jobless claims and anecdotal feedback suggest recently-unemployed tech workers are quickly finding jobs in other parts of the economy.
Supply-chain bottlenecks continue to reduce as Covid pressures ease and demand softens.
Global container trade volumes declined 9.5% in the year to November (and -3.7% YoY so far in 2023). This is expected to continue into December and the first half of 2023 before recovering later in the year.
US treasury secretary Janet Yellen called on Congress to raise the debt ceiling after forecasting the $US31.4 trillion borrowing limit would be reached on January 19 — and extraordinary measures would likely be exhausted by June.
A 2011-like US credit downgrade is looking more likely after it took 15 votes for Kevin McCarthy to be appointed Speaker of the House.
A package of concessions to win over conservative holdouts included a tougher stance on spending.
This has the potential to be a major story for markets over the next six months and should be closely followed.
There is a wide range of potential outcomes from a bipartisan deal to government shutdown or even debt default.
Though it’s most likely there will be an 11th-hour bipartisan deal, even if the path to get there is long, painful and volatile for markets.
Increasingly, it’s looking like Europe’s recession will be shallower than initially thought.
A better-than-expected outlook is due partly to a mild winter and widespread efforts to conserve energy.
This led to a 20 per cent yearly drop in European gas demand during the fourth quarter. There has been a sharp decline in energy prices as retail and industry seek greater energy efficiency.
On the supply side, actions to diversify gas sources via the importation of liquefied natural gas has contributed to European gas storage levels reaching 82 per cent.
This is well above the usual level of about 65 per cent at this point in the winter.
This should provide comfort that sufficient supply is available to maintain lower prices into — and potentially through — the summer.
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The improving economic outlook is further supported by better-than-expected data for UK and Germany.
The UK economy grew in November for the second month in a row after contracting in the third quarter. In Germany early estimates suggest fourth-quarter output was flat versus the previous quarter, compared to expectations of a contraction.
European industrials are also well positioned to benefit from reopening in China economy throughout 2023.
These positive signs have been well received by the market. European stocks have outperformed so far this year (+9.5% vs +4.2% for S&P500 and +4% for ASX100).
Last week was strong across the board.
NASDAQ was the strongest performer for the week while Europe continued to outperform with a solid 9.5% for the year so far.
Looking back to 2022, since 1900 the US 60/40 “worlds and voting retirement” portfolio was down 17% in 2022 — the fifth worst year on record.
Following the ten worst years for the 60/40 portfolio, the median return for the next year is +17% with a 90% hit rate (only the great depression was negative).
The 2023 numbers further support this trend with the stock and bond portfolio off to its best start since 1987 after a return of +4% YTD.
As mentioned in last week’s note, Commodity Trading Advisor positioning is near five-year lows and Mutual Fund Exposure is running the biggest absolute cash levels on record ($235 billion). This should continue to be supportive for upside moves.
In Australia, November CPI was up 7.4% year-on-year (versus consensus of 7.2%). This was an acceleration from 6.9% in October.
Retail trade also surprised with a 1.4% increase in November, reflecting a strong start to the holiday shopping season.
This strong data supports the RBA continuing to hike by 25bps in February — and likely another 25bps in March.
It is still too early for the RBA to consider pausing — and if that’s the case, the housing correction is likely to continue until at least mid-year.
In markets, performance was largely driven by the macro themes with all sectors except utilities ending up for the week. The S&P/ASX 300 was up 3.11% and Small Ordinaries 2.86%.
Elise is an investment analyst with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.
She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.
Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.
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